What it means
Natural gas takes up a huge amount of space, which makes it hard to move across oceans. When it is cooled to about minus 162 degrees Celsius, it turns into a liquid that occupies roughly one six-hundredth of the original volume.
At that size it can be loaded onto specialised ships and carried to buyers who have no pipeline connection. The work is done at liquefaction plants, also called LNG trains.
Each plant removes impurities from the gas, such as water, carbon dioxide and sulphur compounds, and then runs it through heavy refrigeration equipment before storing the liquid in insulated tanks until a tanker arrives. These plants are among the most expensive industrial facilities ever built, often costing billions of dollars and taking years to construct.
Because of that scale, they are usually financed through project finance, in which lenders rely on the cash flows of the project and on long-term contracts with buyers rather than on the owners' balance sheets. A common commercial structure is the tolling arrangement.
The plant owner charges a fee for processing each unit of gas, while the customer owns the gas and sells the liquid product, so the owner earns a steady fee without taking on gas price risk. Others sell the product directly under long-term supply contracts.
The word has a second, looser use in finance, where it can describe turning assets into cash. It should not be confused with the same word in earth science, where it describes soil losing strength during an earthquake.
The context almost always makes clear which meaning is intended. For analysts, the key numbers are capacity, the cost per tonne, and how much of the capacity is covered by long-term contracts.
A plant that is fully contracted has predictable income, while one that depends on selling spare output in the open market is exposed to price swings.
In practice
Real-world examples.
Example
A gas producer without access to pipelines builds a liquefaction plant near its field. The company signs long-term contracts with buyers overseas and uses the contracts to raise project finance for the plant. Lenders agree to the loan because the contracts cover most of the plant's output for twenty years.
Example
A trading house leases capacity at an existing plant under a tolling agreement. It pays a fixed fee per tonne to turn its gas into liquid and sells the cargoes in markets where prices are highest. The house carries the gas price risk, while the plant owner earns its fee whatever the price.
Example
A bank's energy lending team reviews a loan for a new plant. The analysts focus on the strength of the buyers' contracts, the construction schedule and the sponsors' track record. They also test whether the loan can still be repaid if the plant opens a year late.
Formula
Calculation
Tolling revenue = volume processed x tolling fee per unit.
Suppose a plant processes 5,000,000 tonnes of gas into liquid in a year and charges a tolling fee of $120 per tonne, an illustrative fee. Tolling revenue = 5,000,000 x 120 = $600,000,000. If operating costs are $150,000,000, the operating profit before financing and depreciation is 600,000,000 - 150,000,000 = $450,000,000, which is 75% of revenue.Case study
Seen in the real world.
Bluewater Energy is an illustrative, fictional company that planned a liquefaction plant to export gas from a remote field. The plant would cost $4,000,000,000, so the company sought lenders who would accept the project's contracts as security.
Lenders required buyers to sign 20-year agreements for most of the output at a fixed capacity fee, so that the debt could be repaid even if spot gas prices fell. They also required a contingency budget of 10% of construction cost, $400,000,000, because delays and cost overruns are common on projects of this size.
In this illustrative case, the plant was completed a year late, and the contingency absorbed the extra cost. The long-term contracts kept revenue stable, and the lenders were repaid on schedule. The sponsors concluded that the contingency had been the most valuable part of the financing plan.
Watch out
Common mistakes.
- Ignoring construction risk, when large plants often run over time and budget, which can destroy the expected returns.
- Treating the plant's revenue as exposed to gas prices, when a tolling structure charges a fee for the service rather than selling the gas.
- Confusing liquefaction with regasification, which is the reverse process of turning the liquid back into gas at the destination.
Questions
People also ask.
Why is the gas cooled to such a low temperature?
At about minus 162 degrees Celsius natural gas becomes a liquid at normal pressure, shrinking its volume to roughly one six-hundredth.
How is a liquefaction plant financed?
Usually through project finance, with lenders relying on long-term sales or tolling contracts to repay the debt.
Does it have a financial meaning?
Loosely, some writers use it for turning assets into cash, but in most business writing it refers to converting gas to liquid.
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