Need this case analyzed and solved according to the requirements below. I’ve taken some notes as a starter.
6 pillars in depth
Intro: face value of the perspective project and What the purpose of the project/ recom/ key issues
Address the risk
Key analysis specific to the case
Any recent events causing the issue ??
—> 3 facilities discussed:
- Sabine Pass LNG facility
- Sabine Pass Liquefaction facility
- Corpus Christi Liquefaction project (expected to be decided in 2015)
- Lump-sum turn-key contracts to build LNG facility
- Bechtel Corporation
- 2 other companies
- Lump-sum turn-key contracts to build liquefaction facility
- Bechtel Corportation
- Proven technology used in other LNG projects
- First 4 trains used proven technology
- First 4 trains received FERC approval and were fully permitted by 2012
- No OM contract specified, so we assume Cheniere is doing it themselves
- Cheniere is responsible for procuring all natural gas input requirements and delivering these volumes to the project site
- Natural gas supply pricing risk was taken on by offtakers
- 20 year sale and purchase agreements for terminal use (for LNG facility)
- Total SA
- 20 year sale and purchase agreement, fixed price,
- Fixed fee plus 115% of henry hub benchmark natural gas pricing
- 4 customers
- Spain’s gas natural fenosa
- Korea gas corporation
- GAIL Limited (india)
- UK’s BG Group
- Covering 16 mmpta of capacity from trains 1-4
- Derivative to hedge the prices
- Maybe not much commodity price change cuz of the industry?
- Interest rate swaps
- Hurricane insurance??? If the cost of the event happening is low why bother?
- Total capital cost of Sabine Pass LNG approx $1.5b and (1.9-2b after financing costs)
- 2004 raised $306mill through ( LNG ticker)
- Of $ 234 mill downstreamed
+1 regulatory compliance
In summary I need: the 6 pillars to be addressed in details, intro paragraph including an overview of the industry, face value of the perspective project and What the purpose of the project. And finacials model
This case is a perfect example of how the global scenario can change rapidly, and what all a company has to do keep up with those changes. We have seen from past if a company is unable to keep up with the changes that are taking place, they are not able to survive. Cheniere was one such company, who sensing a business opportunity after the collapse of world oil prices in later part of 1990’s, decided to diversify its business from upstream exploration to LNG regasification. This was mainly done to take the advantage of decline in domestic natural gas production which created a deficit of supply of natural gas which was expected over the next decade in the US market. But in 2009 the dynamics of the gas market in the US changed completely resulting in almost no demand for LNG. This resulted in the newly made facility Sabine Pass lying dormant. At the same time the world financial crisis was at full bloom resulting in the increased debt burden on the company. The company was making huge loses mainly because of the interest payment on the debt burden of the company. Than the company took a strategic decision to completely reverse the business of the company and decided to become an exporter of LNG from importer of LNG. The company got into LNG liquefication process and became bi directional liquefication as well as regasification.
The LNG industry of the world has evolved over the past 30 years. Earlier when the company decided to invest in regasification facility the OPEC nations dominated the export of gas to the world. USA was a major importer and needed gas for the purpose of industrial as well as power generation process. When the Cheniere began the production of facility the USA was importing gas, at that time the regassification facility made sense but over the pre-construction and construction phase the whole scenario changed and because of the change in the drilling technique from vertical drilling to horizontal drilling, USA was about to become a major exporter of the gas to the rest of the world. This growth of LNG production in USA was mainly due to the advancement in the LNG drilling industry, including seismic imaging, horizontal drilling and hydraulic fracturing. Also, at the same time it was aided by the drop in the demand in the USA for LNG. With now export on its mind, the USA LNG companies were competing against the world to supply the gas to industry heavy country of Asia such as India and China and Japan. And these countries would buying from those which would be able to provide them at the lowest cost. Unlucky for the US companies, USA being farthest from Asia among the LNG supplier nations, the landed cost of the LNG supplied from USA would be higher to as compared to middle east and Russia, the countries who have been in this industry for quite some time and their economy hugely depended on the export of the gas. Therefore, more likely customers of the US companies would be the Americas and the European countries.
Also, the LNG industry is again evolving, with now more focus on the carbon foot prints. As the world is moving towards emission free, LPG industry is going to face stiff competition from renewable sources and among the LPG companies the competition would be about who is able to produce cleaner source of energy.
Risk & Mitigation Strategies
One of the biggest sources of risk in project financing is the financial risk, this is because the amount of debt that is undertake to complete a project. For the above case the company had to undertake debt from starting to construct the project and then more debt to convert the facility into a liquefication one. These debts have created a fixed cash outflow burden on the company specially during the period when the plant was lying dormant. Till 2013, the Interest Coverage Ratio of the company was only 0.01. The situation of the company worsened after the 2008 global crisis when the yield of the bonds fell and the rating of the company dropped.
Other financial risk involves the exchange risk, as Cheniere earlier used to import the oil and now they are exporting the oil. They always face the currency exchange risk. Also, their revenue is dependent on the international prices of the LPG in the financial markets.
The best way to hedge financial risk is to use the various financial instruments available. For the purpose of rising interest rate risk, they can get into forward rate agreements and interest rate swaps to hedge the risk. Derivatives can also be used to hedge the exchange rate risk and the oil price risk, for this they only need basic derivatives such as futures and options.
This is the biggest risks that this particular industry faces in the coming future. There are already talks about cutting the carbon footprint and that can be done only by switching to the renewable source of energy. Is there is no demand for the gasoline than there is no reason for the existence of these companies. But for that there is a long way to go, still the companies should look to diversify into other business from now on, which would include investing in process of purifying the LPG and also looking into any renewable source of energy.
Political and Legal Risk
The company operates in one of the most politically stable country in the world, but still faces political risk in the form sanctions, that are being imposed on other countries by USA, which are potential buyers. Coming to the legal risk, the company currently does not face any kind of legal risk. For the future purpose, the company can face the legal risk relating to the emission norms only.
There is nothing much for the financial evaluation of the project, the company till 2013 was not able to give positive operating cash flow, it was still incurring operating cash loss, therefore it becomes very hard to determine the value of the firm on the basis of cash flows. The value of the company isi the perceived value of the company not the actual therefore, it is hard to determine. We look at the capital structure of the company which in itself is complicated, because there was a time when around 120% of the capital was financed by debt as the net worth was eroded. Over the years, the company has been able to reduce the debt but still it represents more than 50% of the total capital. Financially the project has failed as it has been almost 10 years there is still no positive cash flow from the operations. It will take another 10 years for the company to normalize its balance sheet. And given the uncertainty of the industry, it is hard to justify the value of the company.