Saturday, 19 January 2019

Freeport sets non-recourse benchmark

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The Freeport LNG Train 1 and Train 2 combined financing set a new high water mark for non-recourse construction project financings. By Jason Webber and Clark Wohlferd ofWhite & Case, andBrent Wahl, Nicholas Gole and Aaron Neus of Macquarie Capital.

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United States liquefied natural gas (LNG) export projects remained a hot commodity in 2014, with none hotter than Freeport LNG’s debt and equity financing of Trains 1 and 2 of its multi-train natural gas liquefaction and export facility at Quintana Island, Texas.

This landmark transaction brought together a wide range of equity and debt investors with aggregate commitments (including for contingencies and cost overruns) of approximately US$11bn, making it the largest financing of any project on any basis in 2014. Moreover, with each of the debt facilities for Train 1 and Train 2 of the Freeport facility structured without completion support from the sponsors, the combined debt financing was the largest fully non-recourse construction project financing in history.

Overview of the project

Freeport LNG owns and operates a 2bn cubic feet per day (bcf/d) LNG regasification facility at Quintana Island near Freeport, Texas, about 70 miles south of Houston, Texas. The facility began operations in June 2008. It comprises seven vaporiser trains, a 4.5 bcf underground natural gas storage cavern, pipeline spurs that connect to the nearby intrastate gas pipeline, a state-of-the-art LNG marine loading berth, two full containment 160,000 cubic metre LNG storage tanks, and control rooms and other associated facilities.

The rapid development of horizontal shale drilling and hydraulic fracturing technology resulted in a momentous market shift in the United States natural gas market. Over the past decade, United States’ proven dry gas reserves increased by approximately 70% with a commensurate dramatic decrease and stabilisation of US natural gas prices. By contrast, LNG prices are typically linked to the global price of oil, rising and falling with changes in crude prices. The historical difference between US natural gas prices and global LNG prices, when combined with the benefits of diversification of supply, has made LNG exports from the US very attractive.

To take advantage of this market shift, Freeport LNG nimbly pivoted 180 degrees to develop one of the world’s largest natural gas liquefaction and LNG export facilities alongside its existing LNG import and regasification facility. When complete, the liquefaction project will comprise a minimum of three liquefaction trains (Train 1, Train 2, and Train 3) with a total expected export capacity of over 15m tonnes per annum (mtpa), which will allow it to process over 2bcf/d of pipeline quality natural gas. The liquefaction project also includes the construction of natural gas pretreatment facilities, a second LNG marine loading berth and a third 160,000 cubic metre LNG storage tank.

The three liquefaction trains that comprise the liquefaction project are being developed and financed by separate project entities. Train 1 of the liquefaction project is owned by FLNG Liquefaction, LLC (FLIQ1), Train 2 is owned by FLNG Liquefaction 2, LLC (FLIQ2), and Train 3 is owned by FLNG Liquefaction 3, LLC (FLIQ3). Each of FLIQ1, FLIQ2, and FLIQ3 (the FLIQs) was established as a wholly-owned subsidiary of Freeport LNG prior to the closing of their respective financings.

The construction of Train 1 and Train 2 was procured pursuant to two separate fully-wrapped fixed-price engineering, procurement, and construction contracts between FLIQ1 and FLIQ2, respectively, and a joint venture comprising affiliates of Chicago Bridge & Iron Company NV (CB&I) and Zachary Holding Inc.

CB&I has also entered into a joint venture with Chiyoda International Corporation (Chiyoda), the most experienced LNG engineering and construction firm in the world. The CB&I-Chiyoda joint venture will act as a subcontractor to the EPC contractor. Both Train 1 and Train 2 will utilise liquefaction technology from Air Products & Chemicals Inc (APCI) and will be driven by electrical motors supplied by General Electric rather than gas turbines, making the liquefaction project the first world-scale electric liquefied natural gas (eLNG) plant in North America.

Both EPC contracts included within their scope of work the construction of the common facilities necessary for two-train operation, including the second LNG loading berth, with the cost thereof divided equally between the EPC contracts. The construction of Train 2 will be staged behind Train 1 with a lag of approximately five months. Train 1 is expected to achieve commercial operation in mid-to-late 2018 and Train 2 to achieve commercial operation in early 2019. Freeport LNG will manage the construction of both Train 1 and Train 2 through a construction advisory services agreement with FLIQ1 and FLIQ2. The EPC contract for Train 3 is under negotiation.

Upon successful commissioning of the liquefaction trains, each of the FLIQs will have the right to use all of the liquefaction trains for the liquefaction and export of natural gas. Under this mutualised regime, the annual liquefaction capacity of the facility will be shared ratably among the FLIQs. As a result, the impact of unplanned shutdowns and other similar events affecting a single liquefaction train is substantially mitigated.

The existing regasification facilities also will be retained, with each of the FLIQs similarly having the right to import and regasify LNG on a ratable basis. As a result, the Freeport facility will become a bi-directional LNG facility and its owners will be able to take advantage of whatever market conditions exist in the future for the import or export of LNG. Freeport LNG will operate the integrated facility on behalf of the FLIQs.

The production from each of the three liquefaction trains was contracted through long-term tolling arrangements whereby the customer is responsible for purchasing its own natural gas from the market and delivering it to the Freeport facility for processing into LNG. The tolling fee paid in consideration of receiving natural gas liquefaction services from the facility is structured as a use-or-pay arrangement which, together with the full pass-through of electricity costs, results in the FLIQs being fully insulated from commodity risk.

FLIQ1 contracted its share of nameplate liquefaction capacity under two liquefaction tolling agreements with each of Osaka Gas Co Ltd (Osaka Gas) and Chubu Electric Power Co Inc (Chubu Electric). FLIQ2 contracted its share of nameplate liquefaction capacity under a liquefaction tolling agreement with BP Corporation North America Inc. FLIQ3 contracted its share of nameplate capacity under two liquefaction tolling agreements with SK E&S LNG, LLC and Toshiba Corporation. Excess volumes are expected to be available for sale to the customers above or to third parties upon commissioning.

Freeport LNG estimates that exports from the Freeport facility will improve the US trade deficit by one full percentage point and result in total economic benefits to the US economy of between US$5.1bn and US$7.4bn per year. The project is expected to be directly responsible for over 3,500 on-site construction jobs and 160 new permanent positions. On a broader basis, it is expected to indirectly create between 24,000 and 30,000 permanent additional jobs across the US.

Freeport LNG is a privately owned limited partnership that has over 130 dedicated employees and full time contractors and a senior management team with over 200 years of combined LNG and other energy industry experience. Additionally, and importantly, Freeport LNG has had over six years of completely safe operations without any recordable incidents.

Overview of the financings

The combined debt and equity financing of each of Train 1 and Train 2 were closed and funded concurrently in November 2014. The concurrent closing was required in order to repay existing indebtedness secured by the LNG import and regasification facility, to address joint funding obligations with respect to the second LNG marine loading berth and other common facilities, and to fulfil the financing conditions to the equity commitments of Freeport LNG’s equity investors.

At closing, Freeport LNG contributed the assets comprising the existing natural gas import and regasification facility to the FLIQs as tenants-in-common. These tenancy-in-common interests provide each FLIQ with a non-exclusive ownership interest in and use of the existing assets, including the existing LNG marine loading berth and LNG storage tanks. Freeport LNG also contributed to each of the FLIQs a proportionate equity interest in certain subsidiaries of Freeport LNG that have real property interests and other existing project assets. Finally, Freeport LNG contributed to the FLIQs the development rights in respect of liquefaction trains.

Third-party equity providers executed commitments in respect of the cash equity financing necessary to construct Train 1 and Train 2, respectively. The US$1.24bn cash equity for Train 1 was provided by Osaka Gas and Chubu Electric (the customers of FLIQ1’s share of the nameplate liquefaction capacity) pursuant to a negotiated joint venture between Freeport LNG, Osaka Gas, and Chubu Electric. The US$1.3bn cash equity for Train 2 was obtained through a competitively tendered auction that was won by Industry Funds Management (IFM). IFM was one of five shortlisted bidders that provided full, compliant, binding bids for the Train 2 cash equity.

Freeport LNG structured the debt financings for Train 1 and Train 2 separately through FLIQ1 and FLIQ2, respectively. Train 1 was debt financed by FLIQ1 through a US$4.369bn fully amortising export credit agency-supported debt financing that was provided by Japan Bank for International Cooperation (JBIC) through a direct loan, a loan insured by Nippon Export and Investment Insurance (Nexi) and funded by Bank of Tokyo-Mitsubishi UFJ Ltd, Sumitomo Mitsui Banking Corporation, Mizuho Bank Ltd, Sumitomo Mitsui Trust Bank Limited, Mitsubishi UFJ Trust and Banking Corporation and ING Bank NV Tokyo Branch, and certain uncovered working capital loans and standby letters of credit provided by such commercial banks.

Train 2 was debt financed by FLIQ2 through a US$4.025bn mini-perm construction financing with an expected take out in the capital markets that was funded by a syndicate of 25 commercial banks and other financial institutions. The Train 2 construction financing has a bullet maturity 2-1/2 years after construction. The Train 2 debt financing also includes a working capital facility.

Upon the consummation of the closing, FLIQ1 became owned by Freeport LNG, Osaka Gas and Chubu, and FLIQ2 became owned by Freeport LNG and IFM. FLIQ3 remains a wholly-owned subsidiary of Freeport LNG.

Highlights of the financings

The Train 1 and Train 2 debt financings were structured without completion support from the sponsors, making the combined debt financing the largest fully non-recourse construction project financing in history.

The total equity and debt commitments of Train 1 and Train 2 are approximately US$11bn, making the combined equity and debt financing the largest financing of any project on any basis in 2014.

The Train 1 equity financing was negotiated as a joint venture over two years, following the execution of a memorandum of understanding among the parties and Osaka Gas and Chubu Electric’s execution of the Train 1 tolling agreements in July 2012. The cash equity commitments by Osaka Gas and Chubu Electric were their largest ever in the US. Freeport LNG was able to secure these equity commitments from the cornerstone tolling customers of FLIQ1 by carefully balancing their interests as tollers, their interests as equity holders, and the broader national interests of Japan in the Freeport project (as evidenced by the debt financing provided by JBIC and Nexi).

The Train 2 cash equity position was the result of a competitive auction. With the amount of cash equity known, bidders were asked to bid the percentage equity interest in FLIQ2 that they would require in consideration for the US$1.3bn equity commitment. Over 80 institutions were approached to participate in the auction, with five ultimately being shortlisted to participate in the final round.

All five of the bidders submitted a conforming binding bid for the full amount of equity required. Due to the strength of the project and the integrity of the bid documentation, Freeport LNG and IFM executed definitive documentation with very limited conditions to closing within six days of receipt of the binding bids in December 2013. The transaction is IFM’s single largest equity investment in the US.

The Train 1 debt financing is the first LNG financing by JBIC and Nexi that does not include a completion guaranty and the largest JBIC financing in the US to-date. JBIC’s direct loan was provided under its Overseas Investment Loan programme. This programme is designed to support Japanese foreign direct investment in projects that are strategically important to Japan. The ability of Osaka Gas and Chubu Electric to obtain LNG on prices based on US natural gas prices fulfils this criterion by allowing Japan to diversify away from oil-linked LNG pricing, as mandated by Japan’s 2014 Strategic Energy Plan. Bank of Tokyo-Mitsubishi UFJ acted as ECA co-ordinator to JBIC and Nexi in the debt financing for Train 1.

The Train 2 debt financing was three times oversubscribed, with aggregate offered commitments in excess of US$12bn. Credit Suisse Securities (USA) LLC acted as the global co-ordinator for the 25-bank syndicate. The mini-perm financing was structured with an anticipated take out in the capital markets during or immediately following construction. The joint lead arrangers, bookrunners, co-structuring leads, documentation agents and syndication agents were as follows in Table 1

Table 1

Notable achievements

Freeport LNG financed the project without completion support by executing fully-wrapped EPC contracts with no buy-down damages for underperformance, by including significant cost overrun support within the equity and debt financings, and through an unwavering commitment to best-in-class technology, including APCI’s main cryogenic heat exchanger (which has been utilised in 87 trains in 27 LNG projects with a total capacity of 257 mmtpa and accounts for approximately 90% of worldwide liquefaction capacity).

Moreover, Freeport LNG successfully structured lenders’ reliability tests for the initial operational testing of the liquefaction trains that fully reflect the fact that the tolling arrangements may not result in the dispatch of the liquefaction trains if the natural gas/LNG market were to be inverted upon commissioning.

Freeport LNG mitigated project-on-project risk in a fully integrated and mutualised multi-train facility through complex, but well-structured, commercial arrangements. Project-on-project risk was mitigated to such an extent that no intercreditor arrangements were required between the lenders to FLIQ1 and the lenders to FLIQ2. Rather, if ever required, each lender group is able to foreclose against its borrower without disturbing the interests of the other FLIQs or their respective lenders.

Moreover, the use of the tenancy-in-common structure ensures that the bankruptcy of a FLIQ would not impinge upon the continuing rights of its co-tenants to utilise the Freeport facility. Finally, no diligence of the financing arrangements or other FLIQ-specific information of either FLIQ1 or FLIQ2 was required by the debt or equity investors of the other FLIQ in connection with the transaction.

Freeport LNG pre-positioned the development of Train 3 such that no consent is required from any equity or debt providers to Train 1 and Train 2 in order to initiate or complete Train 3. This was a fundamental requirement of the transaction given that Train 3 is expected to commence construction in the second quarter of 2015. These commercial arrangements required significant interface between and among all stakeholders in the transaction and their respective technical and legal advisers.

The transaction included many first-in-kind commercial arrangements among the FLIQs. For example, to address project-on-project construction risk, Freeport LNG structured joint funding arrangements whereby each of FLIQ1 and FLIQ2 committed to fund their share of the construction of the second LNG marine loading berth and other new common facilities necessary for two-train operation.

Each FLIQ’s funding of the construction of that portion of such new common facilities necessary for one-train operation was supported by letters of credit and/or guaranties from highly rated entities, thereby fully mitigating project-on-project construction risk in the event that either train does not achieve commercial operation. Similarly, to facilitate the common procurement requirements of the EPC contractor under the separate EPC contracts, Freeport LNG introduced an equipment-sharing regime whereby the EPC contractor has the right to shift equipment from one FLIQ for installation in the liquefaction train of another FLIQ.

These arrangements ensure that the liquefaction trains take advantage of the benefits of a two-train construction project and are installed in the most expeditious manner possible, notwithstanding the separated ownership thereof. Finally, Freeport LNG structured a highly nuanced regime for the common procurement of facility-wide insurance and the application of any resultant proceeds. This regime ensures that the liquefaction trains are restored as quickly as possible upon an event of loss to the benefit of all stakeholders given the mutualised regime for liquefaction services. The regime also maximised the insurance available in the market, benefiting all parties to the transaction.

Freeport LNG structured a fully-wrapped fixed-price turnkey EPC contract for each of Train 1 and Train 2 with no buy down damages for performance shortfalls. As a result, the lenders have assurance that the liquefaction trains will be completed to the level required to service the liquefaction tolling agreements supporting the debt financings. Moreover, as a result of the lack of buy down damages and the commensurate need to exceed minimum acceptance criteria for completion in the base case, Freeport LNG and its equity partners expect that the liquefaction trains will be overbuilt by the EPC contractor in the base case, resulting in meaningful excess capacity that may be contracted in the future to significantly buoy equity returns.

As a precursor to the Train 2 debt financing, Freeport LNG executed through FLIQ2 the first deal-contingent interest rate swaps in any major project finance transaction. These swaps, with initial notional amounts of nearly US$3bn, allowed Freeport LNG to lock in all interest rate swaps required by the Train 2 debt financing many months prior to closing and thereby define its interest rates for the duration of the project. Importantly, the swap providers were fully at risk, with no recourse to FLIQ2, Freeport LNG or IFM in the event that the transaction did not close and the swap providers were out of the money.

Through conservative financial structuring, the projected debt service coverage ratios of both Train 1 and Train 2 were around 2x in the expected case and around 1.6x in the downside case. This healthy coverage, combined with revenues supported by high quality customers, resulted in investment-grade credit metrics for both debt financings.

Deal teams

Freeport LNG was advised principally by Macquarie Capital as financial adviser and White & Case LLP as financing counsel. They were also advised by Credit Suisse Securities (USA) LLC as co-equity placement agent for the Train 2 cash equity auction, Clean Energy Capital LLC as special financial adviser, CH•IV International as technical adviser, Marsh LLC as insurance adviser, Environmental Resources Management Inc as environmental consultant, E&Y as independent accountants, Brownstein Hyatt Farber and Schreck LLP as corporate counsel, King & Spalding LLP as Texas counsel and counsel on all tolling agreements, Norton Rose Fulbright as special FERC regulatory counsel, Duggins Wren Mann & Romero LLP as special Texas regulatory counsel, and Young Conaway Stargatt & Taylor LLP as Delaware counsel.

Osaka Gas and Chubu Electric were advised by Sumitomo Mitsui Banking Corporation as financial adviser, Baker & O’Brien Inc as technical adviser, and Morrison & Foerester LLP as transaction counsel.

IFM was advised by Evercore as financial adviser, Arup Group Ltd as technical adviser, Lockton Companies Inc as insurance consultant, Linklaters LLP as equity financing counsel, and Allen & Overy LLP as debt financing counsel.

JBIC, Nexi and the other Train 1 lenders were represented by Lummus Consultants International Inc as independent engineer, Aon Global Risk Consulting Inc as insurance consultant, and Hunton Williams LLP as transaction counsel.

The Train 2 lenders were represented by WS Atkins Inc as independent engineer, Aon Global Risk Consulting Inc as insurance consultant, Chadbourne & Parke LLP as transaction counsel, and Sutherland Asbill & Brennan LLP as Texas counsel.


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