Author
A few months ago, there was an article in the newspapers indicating that the signing of the long-awaited Host Government Agreement (HGA) between the International Oil Companies (Equinor, Shell and other partners) and the Government of Tanzania was imminent. While this is exciting news, the signing is only the initial step, and therefore it could be of value for wananchi to know what to expect post signing. It is of particular importance for stakeholders that are looking or expecting to venture into some of the opportunities that will come with the project.
The next key milestone after the signing of the HGA is the Final Investment Decision (FID) which will determine if the project is still viable from many perspectives, including economic and technical lenses, and whether it will be implemented taking into account the state of energy transition to renewable sources of energy (solar, wind, thermal) in key markets.
Progressing an LNG project from post Host Government Agreement to Final Investment Decision (FID) requires several activities to be carried out which I have analysed below in more detail:
Technical assessments
These assessments aid in defining the technical aspects of the project sufficiently, and the selection of contractors to undertake engineering, procurement and construction (EPC) works. Technical workstreams will need to complete the pre-Front End Engineering Design (Pre-FEED), Front End Engineering Design (FEED) and EPC Contract and bidding process structuring.
Pre-FEED is a contractor-led initial or preliminary designs for the intended project. The preliminary designs are informed by the initial estimates and evaluation of the size of the gas reserves, the exploitation potential, potential liquefication sites, pipelines routes and sizes. Initial cost estimates are typically based on benchmarked data from similar projects that have been done previously.
FEED, which comes after the contractor led pre-FEED, covers optimization of various plant equipment and configuration options. The basic scheme is selected for the FEED to provide better scope definition to the EPC contract bidders. Two of the key outputs from the FEED are the cost estimate and schedule projection.
EPC Contract and Bidding process structuring: Failure to implement a proper bidding process is likely to result in significant problems with project implementation. Structuring and design of the project contract and the structuring and design of the procurement process are key activities that will be carried out. By properly drafting the contract, the project sponsor will seek to achieve the following.
- Incorporate the structure into the contract, in the clearest and most enforceable way.
- Ensure the contract will be a valid and effective tool for successful contract management especially with the potential changes that may occur during the contract life; and
- Ensure that sufficient protections/safeguards are put in place for both sides (investor and the bidder) towards achieving the project’s objectives.
EPC contract bidding for a greenfield project is usually done on a competitive basis. This is essential to ensure openness and value for money which is associated with competitive bidding.
The commercial assessment
This assessment consists of securing the necessary project agreements and LNG offtake contracts. Some of the agreements that need to be finalised include:
- The domestic Gas Sales Agreement (GSA) which covers a portion of gas that will be sold in the local market.
- The LNG Sale and Purchase Agreement (SPA) is the keystone of the LNG project bridging the liquefaction plant to the receiving regasification terminal. There is no worldwide accepted model contract for a SPA, with most major LNG sellers and LNG buyers having their own preferred form(s) of contract.
- Other agreements including project enabling agreements, shareholders agreements, liquefaction agreements, etc.
The financial assessment
This will rely on the technical and commercial feasibility of the project to structure and secure the necessary capital investments to finance the project.
While it is possible that sponsors can finance this project under corporate finance arrangement, it is typical for the project of this size (approximated at 42 billion USD) and complexity to be financed under project finance arrangement where the project is financed purely on the strength of the projected cashflow over 30 to 40 years. Three key activities need to happen in this workstream, first is building a financial model for the project, assessment of the bankability of the project and third securing financing commitment from various finance providers i.e. financial close, which is the endgame of this workstream.
Developing a Financial Model: A comprehensive and dynamic project financial model needs to be developed. It will typically capture all the key inputs from the technical and commercial workstreams. The financial model will typically cover the entire gas exploitation period which will typically be between 30 to 40 years. The results will be subjected to different sensitivities to see the impact of different scenarios. The resulting financial metrics and ratios will be used to assess the bankability of the project.
The bankability of the projects speaks to capacity of the project company to repay its debt on the agreed schedule. Capital providers usually define some criteria to assess a project’s bankability. Some of these criteria are offtake assurance/certainty, the stability of project revenues, the ability of shareholders/sponsors to provide guarantees (especially during the construction phase), and, particularly relevant to project finance, the ratio between the cash resources generated by the project and the total amounts required to service debt. There are three most common ratios required by capital providers as indicated below:
- Debt Service Coverage Ratio (DSCR): This ratio indicates the extent to which a project’s operating profits cover debt service obligations in each year during the life of the contract. This ratio helps potential lenders determine the credit risk associated with the project. A higher Debt Service Coverage Ratio means that there is more operating surplus to cover debt service payments, and therefore less risk for lenders. Investors and lenders will expect a higher ratio in sectors and countries that are perceived as risky.
- Loan Life Coverage Ratio (LLCR). The ratio is defined as Net Present Value of Cash Flows Available for Debt Service (CFADS) divided by Outstanding Debt over the loan period. The ratio provides an estimate of the project’s credit quality from the lenders’ perspective; and
- Project Life Coverage Ratio (PLCR). The PLCR is the ratio of the Net Present Value of the Cash Flows Available for Debt Service (CFADS), available over the project’s remaining life, to the outstanding debt balance in the period. This ratio is similar to the LLCR, but in the LLCR the CFADS is calculated over the scheduled life of the loan, whereas the Cash Flows for the PLCR are calculated over the project’s life.
The third aspect for this workstream is to secure commitment from financial providers which is the goal of the financial workstream.
Experienced project financiers will structure financing as blended finance, which is the use of funding from various sources, including development institutions and government, to catalyse private sector finance into the project. Some of the instruments used in blended finance include.
- Grant and Technical Assistance: This can be used pre-or post-investment to support the investors/sponsors. The assistance might cover costs that would reduce the overall cost of the project.
- Guarantees: These will be from international development agencies like IFC and are meant to reduce the risk for other investors. First loss guarantee is typical for blended finance whereby a development finance institution takes the first hit on the capital it has provided if a project doesn’t perform well, which gives other investors more confidence to participate.
- Concessional (subordinated debt) which take lower return or extended repayment period compared to a private investor/lender.
Final Investment Decision (FID): The final investment decision (FID) is the decision to make a final commitment to proceed with the project. This decision transitions the plan into the actual implementation of the project. Completion of the government agreements including land allocation and access. In additional to that, the project needs to have completed the financing commitments from various financiers including export credit agencies, multilateral development banks, commercial banks, and other lenders.
While much remains to be done before gas revenues can be realized the HGA is a critical first step. The subsequent activities need to be accelerated to ensure Tanzania, and its people can still benefit from the country’s gas resources before the global energy transition overtakes the appetite for fossil based and less green energy resources.
