Unshakable Peru LNG

PFI 500
16 min read

Along the Pacific Ocean and 600km from the Amazon jungle, Hunt Oil decided to build an LNG plant. In seven years, the organisers had to battle earthquakes – financial, political and subterranean – and then employ legerdemain-like funding and plain persistence to make the US$3.8bn Peru LNG become a reality and PFI’s Latin American deal of the year. By Alan Gersten.

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Brian Swinford, vice-president for finance at Hunt Oil, which started its LNG project in the Amazon jungle, said: "The deal was fundamentally sound. All the pieces fit well together." In 2001, a consortium involving Hunt Oil did preliminary exploration at Peruvian Blocks 88 and 51 in the jungle, where they found a lot more gas than expected.

The question became, what to do with this bounty? Peru couldn't absorb all of the natural gas, which was part of the Camisea pipeline, but the rest of the world certainly could.

"At the time, LNG was hot," said Alejandro J Valencia, director of corporate and investment banking at Société Générale in New York, who helped bring the financing into play. At that time, gas prices were climbing and many other blocks were awarded. For the consortium, the answer was to build an LNG plant.

Naturally, the plant had to be right on the Peruvian Coast, so the LNG could be put aboard ships and sent around the world. Also, the site is far from population centres, which don't appreciate LNG plants in their backyards. Though the Camisea gas pipeline was 600km away in the Amazon jungle, a spur line of about 200km had already been built to Lima. All the LNG plant had to do was construct a 34 inch, 408km line to link up with the outside line, which is now under way and should be completed in 2010. That way there would be no intrusion into the jungle.

The plant itself is a 52ha, greenfield site at Pampa Melchorita, 167km south of Lima. To the east is the Pan American Highway and to the west the Pacific Ocean, enabling easy transit for supplies from Lima and other points while allowing the gas to move from the jungle into the plant.

The site was chosen because it was along the Pacific and near the Camisea gas field. That way, Peru LNG could get the natural gas from Camisea, and the LNG could be easily shipped on to the Pacific and then to anywhere in the world. The organisers are building a marine terminal, which will be finished in March, to bring the gas to the ships. Once the gas is frozen, it will be stored in huge containers aboard ships and then exported. The project is expected to be finished in 2010.

Blessed with natural energy, Peru looked ready for a big project finance development. However, past political problems made Western project finance bankers wary. For example, in 2006, Ollanta Humala, a left-wing politician, ran for president and many feared he would win, ushering in an anti-business, anti-Western government.

"It was a tough time. People were afraid that Humala would reopen contracts," Valencia said. Others feared expropriation and another Venezuela. Those fears ended when Humala lost in a run-off to Alan Garcia, who was much more accommodating to business. In fact, Garcia went to the Peru LNG plant after the financing closed and earlier had met with Ray L Hunt, the company's chief executive officer. With Garcia in charge, businesses accelerated in Peru. The country had a strong economy and now political stability as well as a wealth of natural resources.

Besides the natural assets, Peru had become an inviting investment alternative to Brazil, Mexico, Chile or Panama, the main Latin American nations luring project finance. Developers and project finance bankers point to the country's stable economy, political stability and overall attraction.

For example, southern Peru had extensive mining resources while other parts of the country have deposits of oil and natural gas. Hunt Oil, based in Dallas, saw Peru as a natural for LNG production. While Peru has abundant energy resources, many other countries hunger for them. Hence, Hunt Oil decided on LNG, whereby the gas is frozen, put aboard ships and sent to energy-starved countries and there the LNG is regasified and turned into energy.

It was a great concept. Now, Hunt had to make Peru LNG change from an idea into reality. In 2003, when Peru LNG started, oil was selling at US$28.50 a barrel; since then, it has leapt to US$147, before tumbling back to around US$50. Even at that price, Peru LNG can still make a profit.

Hunt Oil developed Peru LNG and took a 50% interest, but it needed partners. Repsol YPF SA, a large Spanish oil and gas company, holds 20%. Repsol signed an 18-year contract in 2005 to be the off-taker, buying 100% of the gas and eliminating that problem. Repsol will export the LNG around the world, including much to Mexico. Since there are no regasification plants in Peru, none of the gas will be used domestically.

Marubeni, a major Japanese trading company, agreed to buy 10% of Peru LNG from SK Energy Co, a major South Korean energy firm, for US$100m. SK Energy's remaining share is 20%. When structuring the deal, the organisers had a lot of positives. Gas is a highly desired commodity and Mexico was a ready market.

"This will be the first LNG plant on the West Coast of the Americas," Valencia said. Also, this will be the first LNG export facility in South America.

The US$2.2bn financing, which was the largest foreign direct investment in Peru's history, became a matter of mix and match. The project was far too big for a commercial syndication, especially when the economy was listing. To help with the financing, SG brought in the IDB. The imprimatur of a multilateral such as the IDB always makes it easier for commercial banks to invest. Then the US Export-Import Bank joined the project. Next, the financiers expanded to multilaterals around the world, which also increased the deal's allure.

The IDB agreed to a US$800m financing for Peru LNG, using the A and B loan matrix. The IDB would provide a US$400m loan and a B loan of a further US$400m would come through a syndicate of international banks. The A loan was for construction, which will take two years, plus 12 years and the B loan is for construction plus 14 years.

This was a straight project finance loan and, at US$800m, the largest A&B loan in the IDB's history. The margins were 75bp over Libor for the construction phase of the B loan and Libor plus 95bp on the A loan. After the construction phase, the margin was Libor plus 100bp on the B loan, rising to 137.5bp over Libor while the A loan was 20bp above that. The IDB declined to reveal the fees or cover ratios.

Other multilaterals decided to finance the project. The IFC approved a US$300m loan for the scheme, its largest A loan, and other approvals have come from the US Ex-Im with US$450m, Italy's Sace with US$250m, and the Korean Export-Import Bank with US$300m. The tenors were the same on the other multilateral loans.

The bankers welcomed the multilaterals, which are rapidly becoming the lenders of last resort in this troubled economy. However, they bring their own problems.

"It's like we have eight different lenders," one banker said. But he added that everyone was committed to the project. In early April, Fitch Ratings boosted Peru's sovereign rating to investment grade, which cheered SG. "That will definitely help. It could lower interest costs," the banker said.

Commercial banks came on board and the financing took shape. However, the last twine in the financial package remains untied. A US$200m local bond must be completed, but that may not take place until March or April 2009.

During December and January, the summer season in Peru, people go on vacation, so little work gets done, including any bond deals. By the time everyone returns to work and starts processing things, it will be February. Then the organisers have to submit documentation to regulators. With all the bureaucratic necessities, it will probably be at least April before the bond issue is finished.

However, one thing is clear, the bond will be in US dollars. For a while, the financiers had considered using Peruvian soles, but the US dollar's rally and the plunge in other currencies has made the greenback favourite again for this deal. "These are the last dollars," said Hunt Oil's Swinford.

The worldwide credit crisis is making investors around the globe, including Peru, anxious and not eager to invest in long-term paper. The local interest rate for comparable issues is higher than Peru LNG wants to pay, Swinford said. The local rate is 50bp to 200bp over the sovereign rate, which is 8.65%.

Local investors are asking why they should buy Peru LNG bonds instead of sovereign paper. Thus, Swinford wants to educate local investors about the project, the biggest in the country's history. The bond could be issued in tranches, with a shelf life of two years. If Hunt Oil saw a good financial opportunity, it might offer, say, US$50m of the bond and save the balance for later. If the local market becomes uninterested in the bond issue, Hunt Oil may try to market it in the US.

Peru LNG doesn't need the money until 2009-10, said Swinford. The Peruvian regulators and the superintendent of banking must both approve the issue. Already, three local bond rating agencies have given the issue a preliminary rate of Triple A. A final rating would come when the bonds were actually issued. Banco de Credito, based in Lima, is the local adviser on the bond issue. SG remains the project's financial adviser.

The balance of the funding will come from the partners' equity. Overall, the US$3.8bn LNG project will have 60% debt and 40% equity. Already, the partners have invested US$1.2bn in equity. SG and BBVA are the lead arrangers on the B loan, and five other mandated lead arrangers are Calyon, ING, Sumitomo, Bank of Tokyo-Mitsubishi and Mizuho. The organisers are glad they don't have to start financing the plant now. "It would cost 350bp over Libor now, instead of 125bp," Valencia said.

A law firm involved in the project was complimentary about Peru LNG. "The deal was completed during the credit crisis and a bad economy. We should give kudos to the advisers and developers," said Marty Klepper, a partner with Skadden Arps Slate Meager & Flom, a Washington-based law firm that acted as financing counsel for the consortium developing the project. Still, the organisers had hurdles to overcome.

"The biggest problem was that Repsol had a cap on its liability, which was less than the debt amount," said Swinford. "If Repsol couldn't place the gas, then it could walk away." That worried potential lenders. "We had to convince them there was a market for LNG that makes sense," Swinford said. That took six months. "The multilaterals wanted to make sure that the deal works," he said.

Repsol helped convince the lenders when it won a supply contract in Manzanillo, Mexico, to supply 70% of Peru LNG's output. This LNG will go to a regasification plant and replace a 100MW power plant that is currently belching smoke into the atmosphere. Some of the gas will go through a Pemex pipeline to Guadalajara. Repsol hasn't decided where to send the other 30%, but it is talking to potential clients in Asia, the US Southeast and other areas of the world.

A lesser problem was dealing with upstream members of the Camisea pipeline. These companies were not all part of the Peru LNG team, so they didn't have a vested interest in the project succeeding. That worried potential lenders, so the Peru LNG organisers had to agree to make payments if the upstream producers couldn't supply enough gas.

"There would be penalties if we'd have to pay Repsol for not producing enough gas. We'd have to fill that gap,” Swinford said, something he hopes remains theoretical.

But he can point to a lot of practicalities. With its access on the Pacific, LNG has a world of possibilities. When the Panama Canal expansion is complete, large tankers will be able to transit that waterway and easily go to Europe. Also, the new supply of gas could cut Mexican demand for US natural gas and mean lower prices for US consumers.

In August 2007, a major earthquake hit Peru. Officials said there was no significant damage at either the plant site or the main office in the San Isidro district of Lima, so the company had no major project delays. Emergency response efforts that went into action immediately helped operations at the plant site. The Peru LNG gas liquefaction plant is located south of Lima between Canete and Chincha, two of the areas most affected by the quake. The plant was designed to withstand damage from earthquakes such as the one that occurred.

The quake didn't damage the plant or the gas pipeline, but it did damage some bridges on the Pan American highway, preventing supplies from Pisco 300km away coming to the plant. The organisers worked around it. Another earthquake on November 1 shook Lima, but no damage was reported to the capital city or the LNG plant. A seismic area such as Peru could suffer more shocks, but the plant has thus far withstood any tremors.

While nature was not co-operative, the Peruvian government was, aiding the deal's development. The LNG project is expected to attract ancillary foreign investment and directly add 0.4% to Peru's gross domestic product from 2006–10. The plant is expected to produce US$500m a year for the Peruvian government in incremental royalties and taxes over the first 20 years. Besides that, the price of oil has soared in the last five years, making alternate sources of energy more popular.

In a perfect world, the Peru LNG could start another train in the future. For example, Repsol has discovered more gas in Block 57, close to the original finds. Also, Petrobras, the Brazilian state-owned oil company, is drilling in Block 110, also nearby. The organisers plan to produce 600m/cfd, or 4.42mt/y. If either or both of these other blocks yield substantial gas and the market for LNG remains good, Peru LNG could add another train, producing more LNG for shipments around the world.