ISSUES ARISING FROM LNG SUPPLY PROJECT'S STATUS.

(a) Greenfield Project. Usually a requirement of investors in LNG supply projects that LNG offtakers be contractually committed prior to making a Firm Investment Decision (FID) to go forward on the LNG supply project. Conversely, buyers (particularly where buyers are seeking LNG supply via a tender procedure), require assurances that greenfield supply project will be developed, that upstream gas reserves are proven, and that contracts and infrastructure are/will be in place to ensure long term gas supplies. The need to provide assurances to buyers on these issues is particularly important in the case of a greenfield development in a new LNG producing country.

(b) Expansion Trains. Sponsors of existing LNG projects have an obvious advantage in securing further supply contracts. Benefits of economies of scale and sharing of existing port and storage facilities are also a plus. But note that the expansion in the number of buyers and number of cargoes being supplied from common loading port facilities may put pressure on loading port performance. Issues of particular relevance to expansion trains include:

(c) Unless seller retains the right to commingle and allocate quantities equitably from all trains, considerable problems can arise.

(d) Tension can occur between the seller wishing to secure buyer commitment before either taking expansion train FID or committing any volumes, and the buyer, particularly in competitive bids, requiring prior assurances regarding a secure source of supply before awarding a bid or taking FID on the LNG terminal.

(e) Issues of allocation of "excess" LNG capacity among buyers or its availability to seller to sell on a spot basis must be addressed. Typically "excess" LNG is defined as the anticipated volume to be produced in the following contract year less the aggregate of all long term buyer ACQs, after adjustment for SPA volume flexibilities. Buyers under long term supply contracts typically have a preferential right to excess capacity LNG in addition to certain upward flexibility and make-up rights.

A significant amount of excess capacity LNG above baseload committed capacity is becoming available from some LNG suppliers allowing sellers increased flexibility and options (subject to availability of shipping). Before selling excess capacity LNG to short/medium term buyers, sellers must take into account long term buyers' anticipated exercise of upward flexibility & make-up rights. Failure of suppliers to be able to make Make-up LNG available could otherwise result in buyers' make-up rights being regarded as a "sham", and therefore run the risk of the take-or-pay clauses being regarded as a penalty provision.

(f) Gas Supply Arrangements. Seller is usually required by long term LNG purchasers to provide assurances that upstream reserves and supplies will be sufficient to meet the contractual requirements of all seller's customers and other customers of upstream gas supplies. A seller who has successfully developed other LNG supply projects and a supply country which is stable and reputable, will help seller to overcome problems in providing such assurances.

What entity should be seller? - Possibilities: (a) Upstream gas supplier and LNG producer as one corporate entity; (b) Upstream gas supplier - LNG producer contracted to provide liquefaction services to upstream gas supplier; (c) LNG producer.

Sponsors of upstream gas projects typically agree to form a separate joint venture company to sell LNG for a number of reasons: 1. Risk/liability management; 2. Financeability of LNG project; 3. Creation of a separate profit centre with its own management; 4. Tax considerations may require the creation of a separate entity in order to identify revenue streams and take advantage of tax incentives.

Seller's evaluation of impact of buyer portfolio/corporate structure: Principal forms of direct or indirect security typically include: (a) Take or pay provisions of the LNG supply contract; (b) Buyer sponsor guarantees; (c) Letters of credit; (d) Gas/electricity customer payment trust/security arrangements.

The structure of the buyer project can add complexity to the allocation of risk and structuring of back to back security arrangements. An understanding by seller of buyer's market is essential in considering appropriate LNG pricing terms, e.g. indexation, s-curve/floor and ceiling prices, fixed price, price reopeners, net back prices based on buyer's realised gas sales. These are all pricing mechanisms in use (or under consideration) in long term LNG trades. Particularly where buyer is an IPP dependent on tariff revenue under a power purchase agreement, extensive due diligence of market risks is required.

The Dabhol situation demonstrates the importance of looking beyond government guarantees and payment security mechanisms to the fundamentals of the electricity market. Can it absorb the electricity at the contracted price?

Existing buyer portfolio may place restraints on the ability of the seller to obtain more favourable terms from new customers. Seller may find itself dealing with two or more buyers acting co-operatively and who insist on e.g. cargo destination flexibility.