Less Financial Risk in Salt Cavern LNG

California's energy policy makers are coming to grips with the need to make liquefied natural gas imports possible just in time to pick what could be the wrong technology. Industry and policy people have known for some time that NIMBY activism would probably push most new LNG terminals offshore. Fortunately, they thought, there were plans already for West Coast offshore terminals and storage facilities. These needed only to be permitted?not through the California Public Utilities Commission, thank god?for financing to be made available. Then California's gas-dependent generation units would be saved from becoming a set of gigantic paperweights, and all would be well. A senior Schwarzenegger administration energy official assured me last month that "Now that the proper price signals are being sent for natural gas, the financing is going to be available for the [California] offshore plants. We know that, because the companies have told us that they're putting their money on the line." Really. That's interesting. My impression was that even large energy companies and Australian conglomerates use off-balance-sheet project financing for such large endeavors, rather than just whipping out checkbooks when presented with the opportunity. The administration might want to look at the "subject to" language in the letters of intent. As in "subject to" obtaining financing. Off-balance-sheet financing means that the capital for a facility such as an LNG terminal is raised by an entity separate from the sponsoring company or governmental unit. The sponsor will likely contribute some equity capital from its own balance sheet, but the banks or bondholders will have to lend money based on the economics of the project undertaken by the separate entity, rather than the total assets or earning power of the sponsoring company. In other words, if ExxonMobil were to build an LNG terminal using project financing, and if the terminal were to fail to cover its costs, the lenders couldn' go to ExxonMobil' shareholders to get their money back. This means that sponsoring companies tend to be more expansive about promoting off-balance-sheet financed projects, and lenders such as banks and insurance companies tend to be more suspicious and careful in their calculations of financial risk. When the sponsor companies for any of these major projects take these to the project finance groups at their investment banks, there will be a much more rigorous examination of the economics. The banks will be asking: "What about Bishop process facilities? Won't those come on stream at a lower cost, and sooner, than the California offshore projects?" So what's the Bishop process? It is a method of using offshore platforms over salt caverns to unload, gasify, and store LNG. Salt caverns, by the way, don't exist off the California shore. They've been well developed, however, off the Gulf Coast, where the terminals could use existing offshore platforms, pipeline systems, and well-surveyed and developed salt caverns. The technology was developed by Bill Bishop and Mike McCall, two veteran engineers in Houston. Bishop was the manager of the U.S. Strategic Petroleum Reserve, which uses salt caverns to store the government's oil. McCall ran a storage cavern and pipeline for Union Oil in Louisiana. They've licensed the process to Fluor Corp. and Paragon Engineering (also in Houston) and are working on a proof-of-principle project for the Department of Energy in the Gulf of Mexico. The key technological advantage of the Bishop process is that it uses seawater to heat up and gasify the liquefied gas. That makes it possible for the offloading and liquefying process to cost only 15 cents/MMBtu, rather less than the 30 cents/MMBtu to 50 cents/MMBtu of onshore terminals. According to McCall, the development and testing in the Gulf of Mexico have proved that "We can have a salt cavern terminal in place in two years." A number of the projects proposed for the California market would use a "gravity-based structure," which is a giant concrete box on the ocean floor. Construction time: up to four years. As for shore-based gas tanks in California?sure, in your backyard. "We can build a salt cavern-based terminal in the Gulf in half the time and half the cost of a gravity-based structure," he said. That might not be too ambitious a claim, since they're using existing facilities, an experienced local labor force, and a permissive onshore local and state regulatory environment. You might have noticed that the gas would still be in Louisiana or Texas, rather than California. It is, however, not that difficult to use, or expand where necessary, the existing Southwest-to-California gas pipeline system. Cost and lead times are important here, particularly since the Canadian suppliers to California may restrict their shipments sooner rather than later. And while big, expensive projects off California may be fun for state officials, contractors, unions, and promoters to play with, the state has already made too many bets on overpriced energy in the past. So what happens if the project finance people prefer to finance lower-cost Bishop process terminals rather than higher-priced offshore California terminals? If they turn down proposed California terminals, then the state will have wasted a couple of years of planning effort, and ratepayers will wind up having higher gas prices passed through to them for that much longer. A worst case would be for the projects to be partly completed before abandonment, with stranded costs passed through along with higher gas prices until the Gulf Coast-landed LNG is delivered. Another bad alternative would be to have completed, excessive-cost terminals locked into place because of one form of ratepayer guarantee or another. The cross-Pacific producers might reduce these risks by undertaking to offset any cost disadvantage of California coastal terminals by lowering their gas prices?assuming they could be held to those commitments. That would still leave the longer lead time of the California terminals as a problem for ratepayers forced to accept higher electricity prices for the extra couple of years. California is already committing itself to a high proportion of expensive renewable energy sources. That means it has to be especially careful of the cost of sources such as LNG. Once a particular technology has been chosen, big projects have a momentum of their own, as California ratepayers have learned at great expense in the past. Circuit bimonthly columnist John Dizard is a writer for the Financial Times and takes a particular interest in Western energy policy.

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Less Financial Risk in Salt Cavern LNG

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