King & Spalding LLP
LNG projects are structured in a variety of ways. There is no standard structure; however, the tolling model has been used in several recent LNG export projects. In terms of the tolling model, considerations highlighted in this paper mainly address a project tolling model, as opposed to a third party tolling (which will be discussed at a very high level at the end of the paper).
In implementing an LNG tolling structure, characteristically the project tolling company (i) provides a liquefaction processing service to the upstream owners of natural gas for a fee, (ii) the upstream owners of natural gas (or a subset of them) have an interest in the tolling company, (iii) does not assume liability where there is no corresponding recourse against another project participant, (iv) is, to varying degrees, protected from bankruptcy, (v) does not take title to, or risk of loss of, the natural gas, LNG, or by-products, and (vi) does not take any commodity risk. When applying the tolling structure, there can be many variations, so the participants are faced with a number of decisions with respect to structuring within this model. Understanding the decision points upfront will bring definition to the participants’ objectives, and will facilitate negotiations and the preparation of project documentation. Certainty of natural gas supply and alignment with government stakeholders are significant components of project success – there are examples of project disruption and failure when these critical elements of a project fail.
This paper will highlight both (i) a number of determinations that will need to be addressed during the structuring phase of project development and (ii) the need for document consistency in tolling agreements with different parties. This is not an exclusive list of key considerations; it merely illustrates the complexities in and the importance of both early decisioning issues in the structuring process and proper documentation of the tolling arrangement.
Fee Structure and Payment
The fee structure will interplay with numerous other provisions in a tolling agreement. Is the fee for-profit or not-for-profit? Will capital expenses be a component of the fee? Will operating expenses be categorized into variable and fixed? Is all or a portion of the fee payable if the processing services are not available at any point in time? These are all critical questions that should be decided as the project structure is determined. The fee structure may impact the liability regime, financing, and the relationship among the project participants.
Typically, the fee has a component that is payable whether or not the processing service is utilized or made available, either for pre-agreed volumes of gas to be delivered for processing or for a capacity right in the LNG plant. The tolling entity typically requires a baseline cash flow to cover expenses that arise whether or not the processing service is utilized or available. Often times the processing fee supports the project financing for the export facilities. The lenders drive certain aspects of the fee structure to ensure that credit risk is properly placed, and that the payment stream is a constant throughout the life of the financing.
While various forms of security may be required by the lenders, a security over the revenue stream from the sale of LNG and by-products is critical not only to the banks, but also to the other project participants. It is typical that an escrow arrangement (often offshore, for plants in developing countries) be created and a paying agent be designated. This in part gives the banks and project participants a security over the revenues. The use of a secured escrow arrangement gives (i) the banks comfort of having control over the proceeds securing the project debt, (ii) the tolling company security that its toll will be paid, and (iii) the project participants assurance that payment will be made for the liability of a tolling party.
Unlike other provisions of a tolling agreement, the fee structure may not be consistent across project agreements. In order to achieve project success, fiscal viability is critical, and the ability to generate sufficient cash flow to support the project debt and other requirements of the lenders is essential.
Lifting Terms and Allocation
Multiple parties commonly use the services of an export tolling facility. Whether or not the project is a fully integrated project, there are a number of provisions that should be consistent in the various tolling agreements applicable to the same project. Tolling parties will require continuity across the tolling agreements in critical areas.
It is essential that provisions addressing lifting and scheduling terms and procedures (including port use agreements or conditions of use), measurement methodology, and allocation of LNG and other by-products be consistent for all tolling parties sharing common facilities (common facilities include, among other things, LNG and by-product storage tanks, jetties, lifting arms, and related equipment). Clear and non-discriminatory allocation procedures and measurement principles allowing accurate determination of each tolling party’s entitlement to lift LNG and by-products is important not only to the project participants but also to the financiers. Allocation procedures and measurement methodology should apply equally to all tolling parties and should be auditable or subject to expert determination by all tolling parties utilizing common or shared facilities. Lifting terms, measurement, and allocation are often integrated into the tolling agreement; however, it is not atypical for these terms to be included in a standalone agreement that is signed by all tolling parties, thereby facilitating information flow for, among other things, the creation of the feed gas supply schedule, annual LNG lifting program, allocation of LNG and by-products, ship standards and vetting, and determination of liability.
Annual Delivery Program
The annual LNG delivery program should be developed based on information from all tolling parties and implemented on a non-discriminatory basis. It is through the annual delivery program that the tolling parties effect delivery of their LNG and by-products to third parties, thereby monetizing their gas entitlements. Information is gathered annually from all project participants with respect to planned facility maintenance and shutdowns, gas delivery expectations, and other relevant projected events that will impact or influence development of the delivery program. The annual delivery program is usually refined on a monthly basis when the ninety-day forward schedule is developed. This schedule reflects changes to the annual delivery program and further defines the lifting schedule. Development of the annual delivery program is generally fluid and involves collaboration among project participants.
In the context of development of the annual delivery program and ninety-day schedule, the project participants will also need to agree to terms allowing for, or putting framework around, changes to the annual delivery program and procedures for allocating excess liftings on a ratable and fair basis. Cooperation and agreement by all project participants is critical to this scheduling process.
Choice of governing law and dispute resolution provisions should be consistent across the project documentation and in the various tolling agreements. Should a dispute arise under the tolling agreements it is very likely that multiple, if not all, tolling parties using the same common or shared facilities will be impacted. The dispute resolution process is streamlined and more effective if all parties to a dispute are party to the same dispute resolution proceedings. Experts are often used as a dispute resolution option when technical or financial disputes arise. Again, without continuity across the agreements, these provisions may not be available in the event of a dispute if all parties are not subject to the same dispute resolution and expert provisions.
Liability and Recourse
Optimally, a tolling facility will establish a uniform liability regime with clearly defined recourse that is consistently applied and non-discriminatory in nature. The liability and recourse regime applies to the tolling parties, plant operator or operators, facility owners, lifting coordinators, ships using the LNG facilities, and other project participants. Tolling parties under separate agreements require consistent treatment of all users in the event of a failure to supply gas, failure to lift LNG or by-products, off-spec gas or LNG, partial or complete plant shutdown, force majeure, and similar events that may impact all tolling parties. A concise liability regime typically applies across the project, thereby giving project participants and financiers a high degree of certainty should an incident occur.
LNG Sale and Purchase Agreement (“SPA”)
Continuity should exist throughout the project agreements in both substance and in terminology. Most critically, the tolling agreement will likely reflect certain terms agreed to with the LNG buyers in the SPAs, especially if the LNG buyer is arranging transportation and takes delivery of the LNG at the LNG export facilities. For example, port usage terms addressing liability and procedures (sometimes referred to as conditions of use), requirements for notification of approaching vessels, document delivery and facility access rights and limitations, and other document interfaces require a high degree of consistency in both of the tolling agreement and SPAs. The LNG buyers will likely require the continuity, and continuity enables the tolling party to meet its obligation as a seller under the SPAs.
Third Party Tolling
Some recent projects, particularly U.S. projects, adopt a third party tolling arrangement. In this case, the tolling company is a for-profit business, and there is typically little —if any— common ownership throughout the value chain. The owners of the natural gas are truly hiring the tolling company to provide a very specific service and a normal level of business risk is assumed by the tolling company. Many considerations highlighted in this paper will be treated very differently in third party tolling.
Tolling arrangements are complex and critical components of LNG project structure. Imbedded in the tolling and lifting agreement is the mechanism by which project participants are allocated LNG and monetize their gas entitlements. Continuity in tolling agreements among various tolling parties who use shared or common facilities is an essential element of structuring the tolling portion of an LNG project. The structuring phase is key, and decisions made early on will direct negotiations and drive the approach taken in the documentation.