Sabine Liquefaction Deal Faces Hurdles

 | Oct 28, 2011 | 1:45 PM EDT  | Comments
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Cheniere Energy Partners, L.P. (CQP) announced that its wholly owned subsidiary, Sabine Pass Liquefaction, LLC (Sabine Liquefaction), entered into its first liquefied natural gas (LNG) sale and purchase agreement with BG Gulf Coast LNG, LLC, a subsidiary of BG Group plc. BG agreed to purchase 3.5 million metric tons per year (mtpa).

Sabine Liquefaction is planning to develop the ability to produce 9 mtpa. Last May, Sabine Liquefaction received authorization from the U.S. Department of Energy to export up to 16 mtpa.

The terms of the deal is what's important. It is a 20-year agreement with an extension option of up to 10 years. The price for the LNG is indexed to Henry Hub. Specifically, BG Group will buy Cheniere's LNG at Cameron Parish, LA for 115% of U.S. benchmark Henry Hub prices, plus a $2.15 premium.

The premium over Henry Hub must cover Cheniere's cost of liquefaction and leave enough to pay their bankers. It takes energy and money to filter, refrigerate, compress and liquefy natural gas.

This is not a done deal, however. The deal has important conditions that need resolution. Before BG Group is fully committed to buy any LNG from Sabine Liquefaction, Cheniere must first receive all regulatory approvals and secure project financing to build and own these pricy export facilities. Finally, Cheniere must make the final investment decision to construct the liquefaction facilities. When all of these conditions have been met, BG Group is all in. But, not until then.

Sounds like a simple checklist, but it's not. The challenge will be securing project financing. Investors be warned; financing is a big hurdle, and securing it may cost shareholders.

Cheniere's problem is that they have no equity to offer banks. Look at their balance sheet. Cheniere Energy Partners has no shareholders' equity. Zip, zilch, none. In fact, its balance sheet shows shareholders' equity in negative numbers; it's upside down.

They can't even look to their major shareholder, Cheniere Energy (LNG) because its shareholders' equity is also in the red.

Most banks want to see equity in a project before loaning hundreds of millions of dollars. Typically, they expect to see 20% to 30% equity and 80% to 70% debt. Banks also want to see a pro forma that will prove that the LNG project can carry the debt and prove that the bank will get its principal back on time. If Cheniere's financials are weak, the banks will demand higher interest costs, erode projected earnings and possibly sabotage any project financing. Right now, banks are charging developers anywhere from 7% to 11% interest and they insist on being fully hedged.

In order to build the export facility, in all likelihood, Cheniere will need to find an equity partner. It could be Chesapeake Energy (CHK), ConocoPhillips (COP) or even EOG Resources (EOG). The partner may not only take an equity stake, they may need to guarantee the debt – for a price. It appears clear that when that partner arrives, Cheniere's shareholders will become diluted.

The deal may never close. Some disclosures seem suspicious. The terms call for BG Group to buy a variable-price commodity in one market (Henry Hub) and resell it in foreign market. That foreign market is also variable priced, uncorrelated with Henry Hub and cannot be hedged. The end customer is unhedged, BG Group is unhedged or a third party is assuming an $8 billion risk position. But, somebody in this deal is unhedged, which is not the norm in the energy marketing business.

BG Group's offer to Cheniere feels like a stalking horse. It may be a vehicle to prime the pump to motivate other, more substantive players like Dominion Resources (D) to jump into the LNG export market.

More information about this deal is forthcoming. If investors have a position in Cheniere, they may want to consider selling it on the "good news." If investors are focused on LNG, a cost leader in the industry with assets pre-positioned in the Asian market is Royal Dutch Shell plc.

Before anyone uncorks their champagne to celebrate this deal, they may want to wait and see what occurs. This deal is built on a fragile foundation.

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