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 article mainly address a project tolling, as opposed to a third party tolling model.
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) provide for upstream owners of natural gas (or a subset of them) to 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 a tolling structure, there can be many variations, so participants are faced with a number of decisions with respect to structuring. Understanding the decision points upfront will help to bring definition to the participants' objectives, and facilitate negotiations and 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).
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 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. A tolling entity typically requires a baseline cash flow to cover expenses that arise whether or not the processing service is utilized or available. Often a processing fee supports project financing for the export facilities. Lenders also drive certain aspects of the fee structure to ensure that credit risk is properly placed, and that a payment stream is constant throughout the life of the financing.
While various forms of security may be required by lenders, a security over the revenue stream from the sale of LNG and by-products is critical not only to banks, but also to other project participants. It is typical for an escrow arrangement (often offshore for plants in developing countries) to be created and a paying agent designated. This arrangement gives banks and project participants a security over revenues. Use of a secured escrow arrangement gives (i) banks comfort of having control over proceeds securing the project debt, (ii) a tolling company security that its toll will be paid, and (iii) 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 project debt and other requirements of lenders is essential.
Lifting Terms and Allocation
Multiple parties commonly use the services of an export tolling facility. Whether or not a project is fully integrated, there are a number of provisions that should be consistent in various tolling agreements applicable to the same project. Tolling parties will require continuity across tolling agreements in critical areas.
It is essential that provisions addressing (1) lifting and scheduling terms and procedures (including port use agreements or conditions of use), (2) measurement methodology, and (3) 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 project participants but also 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 a 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 a 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
An annual LNG delivery program should be developed based on information from all tolling parties and implemented on a non-discriminatory basis. It is through an 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 typically refined on a monthly basis when a ninety-day forward schedule is developed. This schedule reflects changes to the annual delivery program and further defines the lifting schedule. Development of an annual delivery program is generally fluid and involves collaboration among project participants.
In the context of development of an annual delivery program and ninety-day schedule, the project participants need to agree to terms allowing for, or putting framework around, changes to the 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.
Dispute Resolution
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. A 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
Continuity should exist throughout the project agreements in both substance and in terminology. Most critically, a tolling agreement will likely reflect certain terms agreed to with LNG buyers in sale and purchase agreements ("SPAs"), especially if an LNG buyer is arranging transportation and takes delivery at 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 between the tolling agreement and 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. Owners of 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 here will be treated very differently in third party tolling situations.
Conclusion
Tolling arrangements are complex and critical components of LNG project structure. Each tolling and lifting agreement serves as a mechanism through 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.