Sempra Energy Set to Emerge as Major LNG Player in the U.S.
Sempra Energy (BBB+/Stable/A-2), with two LNG projects in the pipeline totaling more than 2 billion cubic feet (bcf) per day of capacity, appears set to emerge as a major player in the U.S. liquefied natural gas (LNG) market following the expected completion of these projects in 2007. Ratings on Sempra could change, depending on the specifics of the projects. Current ratings do not incorporate the LNG business.
The U.S. LNG Market
The U.S. has been importing small quantities of LNG for more than 30 years, mostly to supply peak needs in gas-constrained markets. Although the 155 bcf imported in 2002 was only a fraction of the 23 trillion cubic feet per year U.S. market, the growing gap between U.S. gas production and demand suggests that the U.S. natural gas industry could be on the threshold of entering the ranks of major long-term LNG importers, such as South Korea and Japan. Production costs in the U.S. appear to be rising as traditional basins mature. Also, the nature of demand is changing, as electricity-generation growth replaces and exceeds industrial gas demand.
Together, these two developments may be moving sustainable equilibrium pricing for gas into the $3 to $4 per thousand cubic feet range, a level that may be adequate to support a permanent LNG market.
Sempra’s Projects
Sempra is developing two LNG terminal and regasification projects—the 1.2 bcf per day Costa Azul Project in Baja California and the 1.5 bcf per day Cameron Project near Lake Charles, La., which it acquired from Dynegy Inc. in 2003. The capital costs are expected to be $600 million and $700 million, respectively. Several major energy players have proposed LNG projects in Baja California and in states bordering the Gulf of Mexico, including Shell Oil Corp., ChevronTexaco Corp., Exxon Mobil Corp. and Occidental Petroleum Corp. However, Sempra’s projects lead the others in getting regulatory approval and will likely be the first among new LNG projects to supply natural gas to the U.S. market in late 2006 and early 2007.
The Costa Azul project has received all major permits from the Mexican government and will likely begin construction in the first quarter of 2004. In September 2003, the FERC granted authorization to Cameron LNG LLC to build and operate the first new terminal for LNG in the U.S. in over 20 years. The FERC’s new policy treats LNG import terminals as gas-production facilities and, as a result, does not require companies to offer open-access terminaling services or to maintain a tariff and rate schedule for such services. This policy, which is a major departure from past FERC treatment, provides companies the opportunity to realize the full economic worth of the asset by allowing for market-based pricing of the capacity. However, it would at the same time expose returns to fluctuations based on the dynamics of the U.S. natural gas market. Construction at the Cameron project is also expected to begin in the first quarter of 2004, after approvals from the local air district and the U.S. Coast Guard are received.
Credit Implications
At this time, Sempra’s ratings do not incorporate the risks of the LNG business, where Sempra’s investment is currently limited to land and permitting expenses. Standard & Poor’s has merely treated the current investment, complete with regulatory approvals, as an “option” that enables Sempra to build the facilities or sell the land and approvals to an interested party if Sempra decides not to enter the LNG business. Standard & Poor’s expects that the project build-out will occur only when the company executes a long-term capacity contract with an LNG liquefaction project with a net-back or similar arrangement that substantially insulates it from gas price volatility. U.S.-built LNG projects will likely be net-back arrangements priced off of a suitable U.S. hub.
If the projects proceed, wholesale gas market exposure would be the single-most important risk to Sempra’s credit quality. An arrangement whereby a gas major with a marketing presence in the U.S. uses Sempra’s regasification facilities for a fixed fee would be the least risky option. Even here, an element of risk can be introduced if the fee is linked to gas prices. Sempra’s credit rating could weaken if Sempra does not contract for all its capacity and decides to retain a certain fraction of its capacity as a merchant operation. In addition, volume risk could also arise if Sempra buys LNG at a hub price less a fixed spread and assumes responsibility for marketing the gas in the U.S., although this is less of a concern owing to the availability of a liquid NYMEX market and gas-trading expertise at Sempra’s trading operations. Assumption of price risk, however, will be the greater concern,.
Sempra recently announced that it will implement the Costa Azul project as a 50/50 joint venture with Shell. This would serve to reduce risks associated with the project as it will require a smaller capital commitment and less capacity to contract out. Sempra is reported to be in discussions with BP Indonesia to supply LNG for its portion of the project. Other terms and conditions of the LNG purchase contract, including the supplier’s credit quality, political and other risks in the country of origin, force majeure clauses, and the economics of the LNG liquefaction project, would also be important considerations.
Standard & Poor’s expects that Sempra would finance its LNG projects, at least in the initial stages, on its own balance sheet, given the significant cash flows generated by Sempra’s utility subsidiaries and by its power sales contracts with the California Department of Water Resources. The extent of debt financing on these projects would depend on the variability of Sempra’s cash flows over the next few years. If Sempra does elect to build out these facilities, Standard & Poor’s would consolidate the LNG operations with the rest of Sempra’s businesses. The resulting business and financial risk profiles would determine the credit quality of all entities in the Sempra family.
Swami Venkataraman, CFA
San Francisco (1) 415-371-5071
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