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