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Liquefied Natural Gas and Gas Contracts

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Gas projects require different types of contracts at different stages of the project development, from upstream to midstream through to downstream. While a significant amount of these contracts are negotiated between private parties, some of the most important ones involve host governments. gas contracts

The ability of governments of resource-rich countries to effectively steward the exploitation of natural resource wealth is predicated upon a number of factors. One of these is the ability to represent the interests of current and future generations in negotiations with private investors and regional partners involved in cross-border natural resources projects.

In that context, an understanding of the different types of contracts, their place in the value chain, and the development of the project, are important. Particular attention should be paid to the technicality and complexity of these contracts. The objective is that governments can prepare effectively for these negotiations, build necessary knowledge to make informed decisions and create dedicated negotiations teams. In addition, contract implementation is equally important and host governments should also build capacity and dedicate resources.

This article aims at providing an overview of the different types and categories of contracts in order to enable governments to prepare accordingly.

PSC v. Licenses

The way in which the upstream contractual arrangements are configured is a complex matter, the basics of which are summarized as follows.

The four contractual structures that have been adopted comprise:

  • Production sharing contracts;
  • Licenses/Concessions;
  • Joint ventures;
  • Service contracts.

Typically a PSC would involve lower risk for the investor in that costs are sometimes recovered in a more timely and efficient manner. However, the mechanisms can be complex and entail longer-term risks and cost recovery in economics. In upstream environments that are more stable and sustainable, concessions may offer a better long-term balance.

Liquefaction plant
Liquefied natural gas terminal
Source: en.wikipedia.org

In the context of LNG projects, the upstream contractual arrangements are not a primary determining factor and have been developed around the world using both primary types of arrangements. Examples of LNG projects under licenses can be found in Qatar, Australia, and the US LNG projects under a PSC/PSA can be found in Indonesia, Malaysia, and Angola. Nigerian LNG projects are based on upstream joint venture arrangements.

Regardless of the upstream structure selected, other legislation (laws), regulations and/or contracts will likely be required for liquefaction and new large-scale natural gas development since many pre-existing host government contracts do not address the specifics of natural gas development. Some of these other contracts are discussed below in the miscellaneous agreements section.

Preliminary Agreements

The negotiation process for the LNG sale and purchase agreement (SPA) can often be quite lengthy and detailed. Given the multi-year timeframe, it is often necessary to demonstrate progress in the negotiating process. Some sort of preliminary document between the parties is therefore often desired to build confidence in the project and, perhaps, document acceptance of specific terms for the government or the investors’ management.

Preliminary documents can include:

  • Term Sheet;
  • Letter of Intent (LOI);
  • Memorandum of Understanding (MOU);
  • Heads of Agreement (HOA).

These documents are listed in their progression of detail and completeness, with an HOA typically representing one step below a full definitive agreement, such as an SPA.

The key issue in all preliminary documents is whether the parties involved are legally bound by the provisions of the preliminary document or whether the parties are still free to negotiate other or different terms, and this may often be a complex matter on which legal counsel would advise. For example, local law may treat some or all of a preliminary document as legally binding even where the preliminary document states otherwise.

Even if a preliminary document is clearly not legally binding, it can lead to disputes if one party later deviates from the provisions of the preliminary document.

Consequently, care should be exercised in entering into any preliminary documents and their use should be limited to only situations where deemed commercially essential.

Domestic Gas Sales Agreement

The domestic Gas Sales Agreement (GSA) follows the typical pipeline gas sales agreement format, with the following key points:

Commitment

The issue is whether the domestic buyer will have a firm “take or pay” commitment under which they are required to pay for supply even if they are unable to accept delivery, or a softer reasonable endeavors commitment. If it is only a reasonable endeavors obligation, the question arises whether the domestic buyer forfeits the right to the committed volumes if delivery is not taken on schedule. By contrast, the LNG plant developer will want to secure gas supply for the liquefaction plant. This includes a take or pay commitment and reserves certification.

The commitments of the seller and the buyer should be balanced.

Price

Pricing of natural gas going to the liquefaction plant may depend on the structure of the LNG chain, whether it is integrated, merchant or tolling. The price may be indexed or may be fixed, with or without escalation. If the structure of the LNG export project is integrated, there is generally not a transfer price between the upstream and LNG plant for the gas feeding the LNG plant. Similarly, the LNG and Domestic Gas Value Chainsdomestic gas price can be fixed and/or regulated, or negotiated between buyers and sellers.

Payment

Domestic gas contracts can be priced in the local currency and this can give rise to foreign exchange risk for the investors involved. Payment currency risk analysis should be an ongoing process. Gas sales for exported LNG are typically priced in dollars, however, the trend in domestic gas sales worldwide has been that payment is typically made in the local currency.

Other elements of a standard GSA include:

  • definitions and Interpretation;
  • term;
  • delivery Obligation;
  • delivery Point and Pressure;
  • gas Quality;
  • facilities and Measurement;
  • general Indemnity;
  • dispute Resolution;
  • force Majeure;
  • suspension and Termination;
  • general Provision;
  • warranty;
  • and indemnities.

LNG Sale and Purchase Agreement

The LNG Sale and Purchase Agreement (SPA) is the keystone of the LNG project bridging the liquefaction plant to the receiving regasification terminal.

There is no worldwide accepted model contract for a SPA, with most major LNG sellers and LNG buyers having their own preferred form(s) of contract. Some international groups, including:

  • “The International Group of LNG Importers” (GIIGNL);
  • and the “Association of International Petroleum Negotiators” (AIPN);

have prepared model form short-term contracts, e. g. AIPN has a model form LNG master sales agreement.

Most LNG SPAs have become lengthy and very detailed documents. However, the main points of an LNG SPA can be summarized below:

Commitment

The commitment made in a SPA, in its broadest sense, is epitomized by the following statement: The seller commits to sell and the buyer commits to purchase.

The elements of the commitment are term, transportation, volume, level of commitment and ability to divert LNG cargoes.

Term

Historically, LNG SPAs have been long-term contracts with terms of 20-25 years. These long-term contracts were needed by both the seller and the buyer to justify the significant investments required by the liquefaction project and by the receiving terminal and the natural gas end-users. The majority of the throughput of the Liquefied Natural Gas Reliquefaction Plantliquefaction plant needs to be tied into these long-term contracts to enable the developer (see the article “LNG project financingFinancing an LNG Export Project“) to secure project finance. As the LNG industry has grown and LNG supplies have become more readily available, there are now some shorter term contracts (5-10 years) for a minority percentage of throughput, but long-term SPAs are needed to underpin financing. Additionally, a growing spot market for LNG has developed as a result of several unforeseen factors:

  • The development of many global LNG export projects to meet expected US demand (at the end of the 1990s and the beginning of the 2000s) where the cargoes were subsequently available to other global markets.
  • The availability of re-exported LNG cargoes from the US and other countries due to reduced demand.
  • The development of tremendous quantities of shale gas in North America and the resulting reversal of a large import destination to an emerging exporter.
  • The Fukushima nuclear accident following the 2011 tsunami and earthquake, the consequent increased demand for LNG in Japan and the uncertainty of the timing of the re-start of their nuclear power plants.
  • The collapse in oil prices in 2014/2015.

Transportation and Discharge

LNG sales can be done on a FOB (free on board) basis, with the buyer taking title and risk at the liquefaction facility and being responsible for transportation of the LNG; CIF (cost, insurance and freight) basis, with the seller being responsible for delivering the LNG to the tanker at the liquefaction plant. The buyer assumes title and risk, but the seller is responsible for the costs of transportation to the destination or DAT (delivered at terminal) or DAP (delivered at place), with the seller retaining title and risk until the LNG is delivered and the seller being responsible for transportation. The terms DAT and DAP replace the delivered ex-ship (DES) terminology that may still be encountered in some forums.

Volume

The SPA will specify the volume of LNG that the seller is obligated to deliver, and the volume the buyer is obligated to take, each contract year (generally a calendar year), and provide a process for scheduling and delivering this volume in full cargo lots aboard agreed upon shipping. The SPA will provide for certain permitted reductions to the committed volume.

For example, this would include:

  • volumes not delivered due to force majeure;
  • volumes not delivered due to the seller’s failure to make them available;
  • and volumes which are rejected because of being off specification.

Level of Commitment

The level of commitment being taken on by both the seller and the buyer is important to understand. If the commitment is “firm“, a failure by the seller to deliver or by the buyer to take the LNG would result in exposure to damages. If the commitment is “reasonable endeavors“, damages would probably not result.

LNG SPAs are almost always founded on a “take or pay” commitment, where the buyer agrees to pay for the committed volume of LNG, even if it is not taken, subject to the right of the buyer to take an equivalent make-up volume at a later time. Take or pay has been the cornerstone of an LNG SPA since the beginning of the industry and likely will continue into the future. However, some LNG SPAs now use a mitigation mechanism, whereby the seller sells cargos not taken and charges the buyer for any reduction in price, plus the costs of sale.

Similarly, the seller seeks to limit its exposure in a shortfall situation – where the seller does not deliver the full commitment – to something less than full damages. Often the seller will be responsible for a shortfall amount calculated as a negotiated percentage (15 % – 50 %) of the value of LNG not delivered, with this amount paid either in cash or as a discount on the next volumes of LNG delivered.

These features, although detailed in nature, can typically involve financial commitments of hundreds of millions of dollars, and are therefore to be negotiated carefully, with the benefit of expert advisors.

Cargo Diversions

Recent LNG SPAs contain the right to divert a cargo to a different market. Where the seller or the buyer diverts a cargo, it is generally done to obtain a higher price. Two key points to address in situations of cargo diversions are the allocation of non-avoidable costs between the parties (e. g. receiving terminal costs, pipeline tariffs, and damages for missed natural gas sales) and whether and how the parties should share in the profit obtained through the diversion sale. This later point may entail anti-competition exposure in some countries.

Price

At the time of writing this handbook, LNG pricing formulas are evolving from largely oil-linked pricing to largely gas-linked pricing, although the full evolutionary process is still underway. As a result, there are various mixed pricing formulas in use, including pricing techniques that modulate fluctuations in oil pricing, such as an “S” curve.

Read also: Quality control of cargo handling work in LNG carriers

One important trend in pricing is the emergence of “pricing review” clauses in LNG SPAs, where the LNG price can be examined and changed at periodic intervals if specified market conditions are triggered. While the intent of these clauses is to preserve a link between a long term contract and the actual market pricing, such clauses can be very contentious and lead to disputes between sellers and buyers.

Technical

Technical provisions to be included in an LNG SPA include provisions on minimum and maximum specifications for LNG (including heating value and non-methane components), measurement and quality testing of LNG, Rules and Regulations for LNGCLNG vessel specifications and requirements, receiving terminal specifications and requirements and provisions for nomination and scheduling of cargos.

Miscellaneous

Aside from the above key components, an LNG SPA would typically include:

  • Provisions for invoicing and payment;
  • The mechanism for delivering gas feedstock into the liquefaction facility;
  • Currency of payment;
  • Security for payment, including prepayment, standby letters of credit and parent company or corporate guarantees;
  • Governing law of the LNG SPA, which typically will be England or New York;
  • Dispute resolution through international arbitration;
  • Conditions precedent;
  • Definitions and interpretation;
  • LNG quality;
  • Testing and measurement;
  • Transfer of title and risk;
  • Taxes and charges, liabilities;
  • Force majeure;
  • Confidentiality.

Miscellaneous Agreements

There are a number of other key agreements that might be necessary for an LNG project, depending on the structure selected. The following is a representative list:

Project Enabling Agreement

Unless specifically authorized by legislation (law) or enabling regulations, a liquefaction project will require some sort of project enabling agreement between the host government and the project sponsors. This project enabling agreement will describe in detail:

  • The scope of the liquefaction project to be undertaken.
  • The legal regime and the tax regime to which the liquefaction project will be subject, including any tax incentives or exemptions benefiting the liquefaction project.
  • The ownership of the liquefaction project, including any reserved local ownership component.
  • The governance and management of the liquefaction project.
  • Fiscal requirements applicable to the liquefaction project.
  • Local content requirements and procurement procedures applicable to the liquefaction project.
  • Government assistance including in connection with acquiring land and other licenses and permissions.
  • Any special local terms and provisions.

Shareholders Agreement(s)

If an incorporated special purpose vehicle (SPV) is to be used, the agreement of the shareholders regarding governance and management will need to be documented in a Shareholders Agreement. The Shareholders Agreement complements and expands on the Articles of Incorporation or other constitutional documents of the SPV.

Liquefaction Agreement

If a tolling structure is selected, the liquefaction tolling entity will need to have a contract outlining the services to be performed, the tolling fee structure for such services and other provisions regarding risks, etc. with the natural gas customer. This agreement may go by many names, including liquefaction agreement and tolling agreement.

Gas Feedstock Agreement

If a merchant structure is selected, the merchant liquefaction entity will need to purchase the natural gas to be liquefied in the liquefaction facility.

The most contentious issues in the gas feedstock agreement are:

  1. the transfer price for natural gas, with the gas seller typically wanting a net-back price and the liquefaction entity wanting a fixed price;
  2. the liability of the natural gas supplier for any shortfall in deliveries, with the gas supplier wanting to limit liability and the liquefaction entity wanting a pass-through of its LNG SPA liabilities.

EPC Contracts

The engineering, procurement, and construction contract(s) for the upstream facilities and the Project Management of the Large-Scale Liquefied Natural Gas Facilitiesliquefaction facilities will need to be negotiated and entered into by the appropriate entity, depending on the project structure.

Financing Agreements

If project financing is used, a large number of financing and security agreements will need to be entered into.

Transportation Contracts

Either the seller or the buyer will need to contract for LNG vessels to transport the LNG to the market. The options are:

  1. own the LNG vessels;
  2. charter the LNG vessels.

In a vessel-ownership model, an LNG vessel shipbuilding agreement will be required.

A vessel-leasing model will typically be either a bareboat charter (charterer provides crew and fuel), voyage charter (owner provides crew and fuel for a single voyage), or a time charter (owner provides crew and fuel for a set period of time).

Facilities Sharing Agreements (FSA)

An FSA applies to LNG complexes with multiple LNG trains and differing ownership between trains. When any new train is built, in addition to the cost of the train itself, the new entrants are required to enter into facilities sharing agreements. These provide for payment of their share of common facilities, such as Accidents Involving LNG and LPG Storage TanksLNG storage, power generation, and LNG berths, etc.

Terminal Use Agreement

In an LNG import project, depending on the project structure, the user of the terminal will enter into a terminal use agreement with the terminal owner.

There are a wide variety of titles for this agreement, although they accomplish the same purpose – use of the terminal for a fee.

Author
Author photo - Olga Nesvetailova
Freelancer
Literature
  1. The Society of International Gas Tanker and Terminal Operators (SIGTTO). Liquefied Gas Handling Principles on Ships and in Terminals (LGHP4) / 4th Edition: 2021.
  2. The international group of liquefied natural gas importers (GIIGNL). LNG custody transfer handbook / 6th Edition: 2020-2021.
  3. American Gas Association, Gas Supply Review, 5 (February 1977).
  4. ©Witherby Publishing Group Ltd. LNG Shipping Knowledge / 3rd Edition: 2008-2020.
  5. CBS Publishers & Distributors Pvt Ltd. Design of LPG and LNG Jetties with Navigation and Risk Analysis / 4th Edition.
  6. NATURAL GAS PROCESSING & ITS ENERGY TRANSITION ROLE: LNG, CNG, LPG & NGL Paperback – Large Print, November 14, 2023.
  7. American Gas Association, Gas Supply Review, 5 (February 1977).
  8. The Society of International Gas Tanker and Terminal Operators (SIGTTO). Ship/Shore Interface / 1st Edition, 2018.
  9. Department of Transportation, US Coast Guard, Liquefied Natural Gas, Views and Practices Policy and Safety, p. IV-3.
  10. Department of Transportation, US Coast Guard, Liquefied Natural Gas, Views and Practices Policy and Safety, p. IV-4.
  11. Federal Power commission, Trunkline LNG Company et al., Opinion No. 796-A, Docket No s. CP74-138-140 (Washington, D. C.: Federal Power Commission, June 30, 1977).
  12. Federal Power Commission, Final Environmental Impact Statement Calcasieu LNG Project Trunkline LNG Company Docket No. CP74-138 et al., (Washington, D. C.: Federal Power Commission, September 1976).
  13. Federal Power Commission, «FPC Judge Approves Importation of Indonesia LNG».
  14. OCIMF, ICS, SIGTTO & CDI. Ship to Ship Transfer Guide for Petroleum, Chemicals and Liquefied Gases / 1st Edition, 2013.
  15. Federal Power Commission, «Table of LNG imports and exports for 1976», News Release, June 3, 1977, and Federal Energy Administration, Monthly Energy Review, March 1977.
  16. Office of Technology Assessment LNG panel meeting, Washington, D. C., June 23, 1977.
  17. Socio-Economic Systems, Inc., Environmental Impact Report for the Proposed Oxnard LNG Facilities, Safety, Appendix B (Los Angeles, Ca.: Socio-Economic Systems, 1976).
  18. «LNG Scorecard», Pipeline and Gas Journal 203 (June 1976): 20.
  19. Dean Hale, «Cold Winter Spurs LNG Activity»: 30.

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