THE OMAN LNG PROJECT: ANOTHER LNG SUCCESS STORY LE PROJET OMAN LNG: UN SUCCES DE PLUS POUR LE GNL

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1 THE OMAN LNG PROJECT: ANOTHER LNG SUCCESS STORY LE PROJET OMAN LNG: UN SUCCES DE PLUS POUR LE GNL Tony Hanna General Manager & Chief Executive Oman LNG L.L.C. PO Box 560, Mina Al Fahal, 116 Muscat, Sultanate of Oman ABSTRACT This paper covers the elements that led to the successful winning partnership between the Government of Oman and the Private Shareholders in Oman LNG. It identifies and explain the innovative strategies that were adopted by the project particularly in (i) its Engineering Procurement & Construction contract tendering (e.g., drip feed the selected EPC bidders with information from the Project Specification work while that was still half complete), (ii) its project financing (e.g., dedicated Financing Team composed of secondees from Shareholders assisted by first class advisors: Chase Investment Bank for financing and Allen & Overy for legal) and (iii) its approach to marketing (e.g., by negotiating first a Heads of Agreement which include all main commercial terms and thus avoiding long Sale and Purchase Agreement negotiation). It thereby examines the reasons for its fast development. 4.R 1

2 RESUME Cet article couvre l ensemble des elements qui ont contribue a la reussite du partenariat entre le Governement Omanai et les partenaires prives de OMAN LNG. On identifiera, tout en les detaillant, les innovations strategiques qui furent developpees et adoptees par l equipe projet et plus particulierement en matiere (i) d appel d offres pour le contrat d ingenierie-procurement-construction, (passer au fur et a mesure, aux companies selectionnees, les informations emanant des etudes de specifications alors que celles ci sont en cours de developpement), (ii) le financement du project, (mise en place d une equipe de financement dediee et composee de representants de chaque partenaire, assiste de conseillers de premier rang tels que la Banque Chase Manhattan pour le conseil financier et Allen & Overy pour le conseil juridique), (iii) et la strategie de marketing (negociation des principaux termes du contrat de vente evitant ainsi les ecueils que peuvent representer une negociation globale du contrat de vente final). On examinera ainsi les raisons qui ont contribuees au developpement rapide du project. 4.R 2

3 INTRODUCTION THE OMAN LNG PROJECT: ANOTHER LNG SUCCESS STORY Five years after substantial quantities of gas were discovered in Central Oman, the Oman LNG Project has established itself as the largest single Project in the Sultanate of Oman and a significant new source of Liquefied Natural Gas for the world s rapidly growing natural gas markets. To the best of knowledge, Oman LNG is now the fastest LNG Project ever put together. From first major gas discovery for export to Sale and Purchase Agreement signing, Oman LNG would have taken only 5 years. By loading first cargo in early 2000, another record will be broken, that of the fastest LNG Project from first gas discovery for export to first LNG delivery within 9 years! This success story is mainly based on a winning Joint Venture, perhaps more aptly described as a Partnership, between the Government of Oman and Private Shareholders The Company was set-up by Royal Decree to handle the Downstream of this gas export project, namely the liquefaction, transportation and sales of LNG. The Shareholders of the project are 51% Government of Oman, 30% Shell, 5.54% Total, 2% Partex, 2.77% Mitsubishi, 2.77% Mitsui, 0.92% Itochu and 5% KOLNG (a Korean consortium). The Upstream of the Project is 100% Government owned and is operated by Petroleum Development Oman (60% Government, 34% Shell, 4% Total and 2% Partex), with responsibility for field appraisal and development, gas processing and transport by pipeline to the liquefaction plant at Qalhat, near Sur where the plant is being built. There is thus a commonality of Shareholding in those involved with both the Upstream and the Downstream, and between buyer and seller of feed gas and LNG which makes for improved synergies. ELEMENTS FOR A WINNING PARTNERSHIP There are usually several key elements that contribute to the success of a project, be it LNG or other. In Oman LNG, a look back and analysis was carried out to try to understand what makes Oman LNG such a successful and appealing Project. There are three core ingredients required for the production part of an LNG project, being gas, technology and money. The key to a successful project is bringing the three elements together simultaneously, and meeting the aspirations of their custodians. Gas, in the case of Oman LNG, is with the Government, whilst the technology is with the private sector. The money is with the Shareholders and financiers. But all this is no good without a market and so it is a case of developing a partnership with the common goal of supplying and buying LNG. 4.R 3

4 This may all seem somewhat of a truism, but with the financial and resource commitments involved, the integrity of the whole LNG chain is crucial to the overall success of the venture. Set out below is some background to the most important of these elements or basic ingredients. 1. Substantial Gas Reserves The first reason for the conception of an LNG Project is the availability of abundant gas reserves for export. The Sultanate of Oman has substantial gas reserves and these are growing steadily, with potential for much more to be found in the future. It was in 1989 that an exploration well in Saih Nihayda confirmed the Andam gas formation at a depth of 4500 meters in North Central Oman as an important gas exploration play. But, it all really started when significant discoveries were made in 1991 in the Andam reservoirs in three fields (Barik, Saih Rawl and Saih Nihayda (see map, next page). These brought total gas reserves greatly in excess of those required for domestic consumption well into the next century. Since it has always been the policy of His Majesty Sultan Qaboos bin Said to diversify the sources of the country's revenues, it was decided to capitalise on this new resource through export earnings and seek energy deficient countries as outlets for the gas. The large requirements for natural gas are in the Far East, in Asia and in Southern Europe - all in distant markets. In order to access these markets and to achieve maximum return and sales of the product, it was agreed to transport the natural gas in bulk in its liquefied form. This was the basis for the foundation of the Oman LNG Project in The gathering of 3D seismic data over these three Central Oman fields, together with the exploration results, have led to an increase in 'proven' gas reserves from 3.3 Tcf at the start of the appraisal in 1992 to 12.3 Tcf as of with expectation reserves at 17.6 Tcf. The continuing exploration and appraisal campaign is expected to result in further updates of reserves. The majority of Oman's gas reserves are found in non-associated gas fields. Over the past 4 years, the total expectation of non-associated gas reserves have more than doubled and on stood at around 25 Tcf. The gas is rich and of high quality, with low inerts (around 1% CO 2 ), no H 2 S and high condensate ratio, all of which make it particularly attractive for development. There is a good raw material in the gas, and the desire of the resource holder to realise its economic potential. 4.R 4

5 Sultanate of Oman Existing and Future Gas Systems SOHAR LNG PLANT QALHAT MUSCAT LEKHWAIR NIZWA SUR YIBAL SAIH NIHAYDA SAIH RAWL BARIK 360 km PIPELINE CENTRAL PROCESSING PLANT ARABIAN SEA SALALAH 2. Host Government The Resource Holder Under the wise guidance of His Majesty Sultan Qaboos bin Said, Oman rapidly developed, within a quarter century, into a modern, prosperous and politically stable state. It is also very well respected in the international community. Oman is envisaged to be soundly and prudently managed, has a robust economy and financial stability that is the envy of many developed countries. In June 1995, under the wise guidance of His Majesty, a vision for Oman for the year 2020 was formulated. Oman has thus set-up long-term strategies and goals for itself such as further development of the private sector, human resources development, economic diversification, preservation of the environment etc. Oman s experience in oil and gas production goes back some 3 decades. Petroleum Development Oman, the largest oil company in Oman, has grown to be one of the largest in the Gulf. Oman already has an established international oil trade, and the opportunity to 4.R 5

6 export LNG builds on these existing trading relations. The countries that are going to purchase LNG from Oman and those most likely to do so in the future have already a long established track record in oil trade with the Sultanate. The political, financial and economic stability of the Sultanate added to its wealth of experience in the oil & gas business, not only contributed to the rapid development of this LNG Project but also inspires confidence and reliability to LNG buyers and financiers. 3. Private Shareholders of International Renown Realising that the development of an LNG Project is a mammoth task, Shareholders were sought who could bring the other core ingredients of technology and money, and of course help to secure the market and financing. Shell, Total, Partex, Mitsubishi, Mitsui and Itochu, Oman LNG's Private Shareholders, are some of the world's most financially sound, longest established, internationally respected and most experienced companies, especially in the LNG field. They were joined by KOLNG, a Korean consortium itself constituted of Kogas, Samsung, Hyundai, Daewoo and Yukong, representing some of the best known companies in Korea all with an international reputation. But a crucial additional element is that all of the Oman LNG Shareholders have long established working relationships between them. Shell is in various LNG projects with Mitsubishi, and in the Australia LNG project with both Mitsui and Mitsubishi, while Total and Mitsui have common interests in the Abu Dhabi and Qatar projects. Kogas sources its LNG supply for Korea mainly from Indonesia, Malaysia and Brunei, LNG suppliers where Shell and Total have been involved for a long time. However, the long-term relationship that provides the foundation for the development of this Project in Oman is that of the Government of Oman, Shell, Total and Partex who have worked together in Oman since 1937 in what was a forerunner of PDO and now in PDO itself. The similarity of Shareholding between PDO (Upstream) and Oman LNG (Downstream) as well as the technical services provision by Shell to both PDO and Oman LNG is a significant strength of the Oman LNG Project and contributes to the solidity and reliability of the LNG supply chain. 4. Technologically most advanced LNG Plant LNG technology is not new, but seeking the economic advantage through advances in technology is borne out of operational experience. And in the case of Oman LNG, this was provided in house, and has resulted in the Oman LNG plant being the most technologically advanced LNG plant in the world to date, designed to produce a nominal 6.6 million tonnes per annum (mtpa) LNG into storage from 2 LNG trains. The Technical Adviser, utilising Shell Group research and development plus experience from other ventures, has designed this LNG Complex that will be a world leader in terms of production volume. This Design was achieved with conventional technology and proven equipment design (e.g., maximum size of available equipment), ensuring the crucial element of reliability. 4.R 6

7 This technically complete and advanced design took over 300,000 man-hours to put together. Its integrity is further assured by the fact that the design was verified by the 4 EPC tenderers who have each issued a Verification Certificate. All this adds to buyers and lenders confidence in the OLNG plant reliability. It is also worth noting here that lenders have subjected the design to independent scrutiny and have satisfied themselves in such respect. 5. Location Location, although not a core ingredient for an LNG project, is certainly a crucial one. When referring to location, it is both the location of the country of export and location of the LNG plant within it. Again, the Oman LNG Project scores extremely high on both. The Sultanate of Oman enjoys a geographic advantage by being outside the Strait of Hormuz; a matter that enhances the reliability of the Project in the eyes of LNG buyers and Project lenders. But of equal importance to the buyers is the political and economic stability of the Sultanate which sets an example to the world. However, within this benign environment, the LNG plant will be located near a natural harbour at Qalhat on the North East coast of Oman some 15 km North of the town of Sur and some 200 km south east of the capital Muscat (see map above). This site is exceptionally attractive due to the fact that it is naturally well protected from severe ocean currents and tropical storms and has deep water within close proximity to the shoreline, the jetty only needing to be less than 500 meters long. In fact, it is a natural harbour which does not require a breakwater or dredging and which LNG ships are expected to be able to access virtually 365 days of the year. The attributes of the location not only contribute to the economics of the Project, but again enhance the reliability and safety of the LNG supply chain. Being close to the town of Sur, there is also a commercial infrastructure on which to base the Project and the services it requires. 6. Timing Timing in getting an LNG Project off the ground is most crucial. Oman LNG was put together with the vision and analysis of an LNG supply/demand gap developing in the year Oman LNG is now looking forward to satisfying some of this demand in the early years of the next century. Moreover, the timing for constructing an LNG plant happens also to be at its optimum. This could be called luck or foresight or careful planning; contracting cost as well as equipment costs fortuitously appear to be in the trough of their cycle, thereby further contributing to the sound economics of the Project. 4.R 7

8 7. Economic Fundamentals and Financing The combination of the resource availability, location, technology and all the Shareholders, linked with the market, lead to this project being seen as commercially very robust. The sound economic base has secured the interest of the financiers who see the venture as a good risk and are therefore keen to provide that third core ingredient of money. The aspirations of the financiers are being met through the involvement in what is considered to be a prestigious venture with first class Shareholders and a stable country with sound financial management. The commercial and political fundamentals of the project mean that both Arranger Banks and Export Credit Agencies have a high desire to be involved and have committed themselves to a high level of debt/equity ratio.. 8. Transparency/Trust between Partners In this kind of project, there is a large amount of (technical, commercial and financing) information that has to flow from the Company to the Shareholders as well as between Shareholders. There is information such as local requirements, gas supply and availability in which the Government has more understanding and experience than the Private Shareholders while in other cases such as with technical and marketing expertise it is the opposite. To acquire a good understanding of all issues and to enable balanced and speedy decisions to be taken from all sides, there is no really perfect recipe. What was and is being followed in the Oman LNG Project is simply good and timely Communication of all information to all Shareholders and between them, thus leading to Transparency of all issues at stake. And Transparency leads to Trust and Trust is the basis of any good and Successful Business, and was one of the pillars on which the Winning Joint Venture was built. There is still a large amount of work to be done, but this concept of Transparency and Trust should help us sail more smoothly through to first cargo. Finally, if the Oman LNG project is a successful venture, it is also because it has given itself the capability of successfully incorporating all the above factors and achieve its goals. Oman LNG is a joint venture between the Government of Oman (owner of the gas), Shell as operator of the project and 5 international oil companies experienced in the oil and gas business, plus a Korean partner from the buyers side. Oman LNG has endeavoured, each time it was possible, to integrate into its staff representatives of shareholders. This aided the Company in establishing shareholder ownership in its development plans. To the outside world Oman LNG appeared as a team of experts from different renowned companies, working hard to establish a new project together with, and on behalf of, the Government of Oman. This special type of organisation has enabled full support from all the shareholders to OLNG initiatives. Beside being a successful project, OLNG is a model of a successful company that effectively met the aspirations of the custodians of the three core ingredients of the project being gas, technology and money. 4.R 8

9 ELEMENTS FOR A WINNING VENTURE First Class Shareholders Reputable Host Country Substantial Gas for Export Prestigious Venture Latest Technologies Excellent Location Perfect Timing Robust Strategies Sound Economics Successful Marketing and Financing CONCLUSION From the analysis of the core ingredients, all stakeholders in the Oman LNG Project are winners: - the Government will be exporting its gas with value added and will have a new source of revenue. There will be technology and skills transfer to the country. A large number of jobs will be created by the Project while the town of Sur will see a revival, - all Shareholders are making a sound investment in this Winning Joint Venture, and - financiers are putting their money in a secure and reliable Project. These together make LNG from Oman a very attractive source of energy for its buyers offering them safe, reliable and secure long term supply of LNG. STRATEGIES Further to the elements contributing to the success of the venture, the Company adopted and followed defined, structured and robust strategies, especially in the fields of EPC contracting, marketing and financing. 4.R 9

10 1. Contracting Strategy The contracting strategy centred around a thorough evaluation of the Project s potential with an identification study, followed by a feasibility study and a Basis of Design. This was followed by the Project Specification phase, or front-end engineering, which was to be fully comprehensive. This phase took one year to finalise with over 300,000 man-hours resulting in 84 volumes of data and drawings. In order to optimise the contracting schedule, and to ensure that all bidders had the same information in a timely fashion, it was decided to drip feed the 4 pre-selected EPC bidders with information from the Project Specification work while that was still being completed. This strategy ensured that they received information in adequate time for them to prepare quality bids and that all bids could be provided on a unified basis. The 4 EPC bidders were also asked to produce certificates of verification for design and specification in order to avoid future potential changes and thus mostly eliminating the risk of cost overrun. Finally, the bidding process was split into two steps. In the first step, the technical bids were received, evaluated and normalised. This step enabled the Company to ensure that all bids received conformed fully to the bid requirements, were adequate and consistent. The second step took place a few months after when the priced bids were submitted. The EPC bidders were asked to provide alongside their offer, letters of support from Export Credit Agencies thus supporting the financing strategy. The criteria for bid evaluation was declared prior to submission of bids, thereby creating a level playing field. The preferred EPC bidder was selected in June 1996 and EPC contract was signed with Chiyoda Foster Wheeler & Company in November 1996, signalling final commitment to the project. 2. Marketing Strategy Following a LNG supply/demand analysis determining the market opportunities, and based on Oman s geographic location, it was decided to target markets not only in the Far East, but also in Southern Europe and Southeast Asia. In order to support the project financing that the Company was seeking, an initial first class buyer was sought. This was successfully achieved when a 25 years Sales and Purchase Agreement was signed with Kogas of South Korea for the sale of 4.1mtpa, representing some 65% of the Oman LNG project capacity. This was further enhanced with the signing in October 97 of a Heads of Agreement with Osaka Gas of Japan for the sale of 0.7Mtpa over a 25 years period starting in November For the remaining volumes, Oman LNG s strategy is to keep a flexible approach vis a vis other markets which may be considered perhaps more challenging than the long established Japanese and Korean markets because of the lack of gas infrastructure. The LNG market is evolving fast and new markets will be emerging. Today, Oman LNG s marketing team is actively pursuing sales in India and other emerging markets, where market conditions require innovative approaches in order to account for each particular situation. 4.R 10

11 The marketing strategy for OLNG has focused on a three steps approach. The initial agreement with the buyer is generally a letter of intent, which contains little details and for many buyers cannot be considered as binding. It is normal that such an agreement is followed by the lengthy negotiation of the final Sale and Purchase Agreement. However OLNG decided to introduce an intermediate stage with Heads of Agreement. This agreement has a limited life and provides all the key commercial term. Its signing evidences a much higher level of commitment between the parties than does a Letter of Intent. The agreement also allows the Seller where necessary to confirm the level of support from the buyer s Government. Thereafter the negotiation of the SPA can be achieved in about 4 month in our experience. 3. Financing Strategy The objective of the Company was to maximise third party debt. A dedicated Financing Team was set up with the task of arranging Project financing. The Team was composed of secondees from Shareholders and jointly headed by a senior Government representative and a Shell secondee. The financing strategy included selecting first class advisors from the outset to assist Oman LNG Financing Team. Chase Investment Bank and Allen & Overy were selected financial and legal advisors respectively. It was then decided to have a competitive and negotiated approach to the selection of one group of Arranging banks. Seven banks were selected. The strategy required that EPC bidders arrange Export Credit Agencies (ECAs) cover based on the sourcing of the equipment for the plant in order to support commercial loan. The unconditional commitment from the arranging banks and commitment letters from the ECAs was obtained as part of the conditions to take Final Investment Decision in October During 1997, these commitments were converted into the Final Loan Agreement which was signed on the15 th of November The total facility amounts to $2bn, which represent 80% of the currently envisaged cost of the downstream Project. Four major Export Credit Agencies from US, UK, Italy and the Netherlands provide cover for the loan. 41 banks will provide the funds under the facility arrangement. CONCLUSION Oman LNG is now building the 2 largest capacity single LNG trains in the world. The 4.1 mtpa LNG sale and purchase agreement with Kogas is the largest between a single buyer and a single seller. For the Gulf area, an unprecedented 80% project financing was achieved. Note: The status of the Project development/implementation as of May 98 will be presented at the conference. 4.R 11