The Qatar – Kuwait Pipeline Project The Economic Model
This case was written by Société Générale Corporate & Investment Banking Department for Professor Antoine HYAFIL, Holder of HEC Paris DELOITTE-SOCIETE GENERALE Chair in Energy & Finance
April 2009
1.
The Qatar Kuwait Gas Pipeline
1.1.
Introduction The case study presented below is inspired from a commercial advisory report performed by Société Générale in the context of its financial advisory mandate conducted between 2001 and 2002 for ExxonMobil (“EM”), for the construction of a pipeline connecting Qatar with Kuwait and supplying Qatari natural gas to Kuwait. Following border litigations with Saudi Arabia, EM and Qatar Petroleum (together, “the Sponsors”) elected not to pursue further the financing of the project in 2002, illustrating one of the risk aspect developers and financiers have to address when working on a stand-alone large infrastructure project.
Proposed Pipeline Route
1.2. Project description 1.2.1
The framework The Project (the “Qatar-Kuwait Gas Pipeline Project” or the “Project”) involves the construction and operation of a 535 km pipeline from Ras Laffan in Qatar to Mina Al Zawr in Kuwait. The preferred route for the pipeline is an offshore route, and thus the pipeline is expected to transit through the territorial seas and continental shelf of Bahrain and Saudi Arabia. The Project is considered a landmark project in the Gulf that will promote cross-border gas trade and gas-based industrial growth in the region. The Project is also key to Qatar’s strategic plan for ongoing utilization of the country’s massive gas reserves, derived primarily from the North Field. The pipeline will deliver natural gas produced by EM and Qatar Petroleum (“QP”) in Qatar’s North Field to the petrochemical facilities of Kuwait Petroleum Corporation (“KPC”). EM will also invest upstream in the gas field extraction. EM is looking to maximize its return in the global project, viewed from an integrated upstream/midstream perspective. However this exercise will only address the midstream component.
1.2.2
The Parties
Pipeco (the SPV) The SPV will own the pipeline assets and related facilities of the project. Pipeco provides transportation services for the gas produced by the Shippers (EM & QP). The Shippers and Pipeco will enter into a Gas Transportation Agreement (“GTA”) setting up the terms and conditions of the transportation services incurred by Pipeco. The GTA governs the circumstances under which the Shippers are obliged to pay the pipeline tariff and conversely, when the payment is excused, the tariff level and structure and the conditions under which the GTA can be terminated. This agreement will be linked to the Sales and Purchase Agreement (“SPA”) under which KPC will acquire the gas from the Shippers. The GTA is structured as a ship or pay obligations in which the Shippers are required to pay the tariff to Pipeco, whether or not they produce the gas subject to Force Majeure and Excusing circumstances. As in the SPA, the GTA will include penalty and termination rights provisions. Tariff structure is expected to include fixed components (covering opex, tax, transit fees and other government’s charges, debt service and equity remuneration) and a variable component related to volume of gas shipped. Pipeco will enter into four Host Countries Agreements (“HGA”) and an Intergovernmental Agreement (“IGA”) with the countries the pipeline is expected to cross. IGA/HGAs will establish critical elements of the regulatory framework governing the operations of Pipeco and its investors with respect to:
Tax regime, transit fees and any other government user fee
Corporate structure and local ownership requirement
Shareholders rights transfer restriction
IGA and HGAs will ensure a uniform, simplified, regulatory framework the most compatible with the success of the operation. The Shippers (QP and EM) The shippers will enter into two major contracts: 1) The Sale Purchase Agreement with Kuwait Petroleum Corporation The SPA will generate the revenues to be used by the Shippers to, among other uses, pay Pipeco for its transportation services. Key provisions of the SPA are:
Take or pay levels under which KPC will be obliged to pay for gas, even if it does not need such a gas (subject to Force Majeure issues)
Annual contracted quantities
Penalty obligations (governing failure from the Shippers to deliver gas)
Circumstances excusing payments by KPC
T e rmin ation r ights
The SPA will create an obligation on the part of the Shippers to deliver gas to city-gate Kuwait, which means that KPC will not have to assume transportation costs separately than gas price. 2) The Gas Transportation Agreement with Pipeco The GTA is structured to work within the contours of the SPA so as to effectively mesh, to the greatest extent possible, the Shippers rights and obligations under the SPA with its obligations and rights under the GTA (“back to back” principle).
The Purchaser (KPC) KPC will enter into a SPA with the shippers to be provided with gas, CIF (which means the price paid by KPC covers the price of gas and the cost of transportation via the pipeline) in its facilities. The Construction Companies Construction companies are responsible for the construction of the various elements of the Project. Several contracts governing specific tasks (pipeline manufacturing, installation, and compressor) will be awarded to several contractors with an overall manager appointed to coordinate the process. No lump sum, turn key contracts with extensive liquidated damages would be contemplated in order to lower the project’s construction costs. The Lenders Lenders will lend to Pipeco on the basis of a non recourse financing. They will be exposed to the project risk to a certain extent, should the forecast cash flow necessary to pay interests and principal not materialize. Host Countries Host countries will be Qatar, Bahrain, Saudi Arabia and Kuwait. They must be supportive of the project and authorize the pipeline construction as well as the transit of natural gas in their territorial sea. Host countries must also agree on a simplified / harmonized regulatory framework that will govern the projects and impacts its economics. 1.2.3
Illustration The chart below illustrates the legal and financial framework being put in place on a typical gas pipeline project financed via recourse finance.
L
Sponsors
Lenders
Fees, tax, charges
Debt Service Equity
Tariffs (governed by GTA)
Legal and Financial Arrangements Gas payment (governed by SPA)
Rights of use, regulatory framework
2.
Natural Gas Pipeline Project Modeling
2.1. Assumptions Background
Financial Close is to occur on 01/01/2010 and the project will have received by then all necessary permits and approvals to kick-off.
Construction is expected to be completed 2 years post Financial Close (31/12/2011). Following completion date the project will operate during 15 years
Construction costs excluding interests and fees are expected to amount to 600 M$ and will be financed by a combination of debt and equity under a gearing of 70:30.
Construction costs Construction costs referred to above will be paid by the project company according to the following schedule. Construction cost are fixed, un-inflated 2010: 350 M$ 2011: 250 M$ Revenues Capacity: 50,000 thousand cubic meters per day.
Utilization Rate: 100% the first year, reduced by 2.0% each subsequent year (98%, 96%, 94%...).
Tariff: 16.5 $ / thousand cubic meter (fixed, un-inflated). Operating Expenses
1
Fixed costs: 15 M$ per year. Variable costs: 7.5 $/ thousand cubic meter. Senior Debt
Amount: 70% of total project costs (construction costs + interests and fees during construction period)
Drawdown: please assume for interests calculation that debt will be drawn mid year
Upfront fees: 200 bps (of debt committed payable at Financial Close)
Commitment fees: 80 bps (of undrawn portion of debt, annually in arrears)
Interest rate annually in arrears:
~ 6.0 % per year on drawn amount during construction period ~ 6.5% per year on outstanding amount during operation period
Repayment over 10 years on a constant annuity basis (i.e. constant interest + principal) from project 2 completion date
Asset and Amortization
Asset value base: total project costs (interest during construction will be treated as assets to be capitalized instead of as charge at the P&L level)
Asset amortized over 15 years on a constant linear basis. Taxes 33 % of taxable profit. 1 Costs are inflated 2% per year starting at the first anniversary date from Financial Close. 2 It means the first repayment will occur at the end of the first operational year
Equity
30% of total project costs
100% dividend distribution policy (disregard any allocation to legal and statutory reserve)
2 . 2 Questions 1. Calculate Project Net Present Value and IRR under different scenarios. 2. What are the main project risks and what are their potential impacts to the project? 3. If you were a banker would you finance the project? What conditions would you negotiate?
