Importing LNG into the US?

Importing LNG into the US?

March 01, 2006

Companies planning to import liquefied natural gas into the United States should consider in advance the various US corporate, legal and regulatory risks and liabilities that may arise in connection with this business.

These risks are manageable for any sophisticated company. There may be multiple solutions to some of the issues, depending on the company’s business model. What is important is that care be taken in considering the issues and thought be given to the implications of selecting particular approaches.

Choice of Entity

There are advantages to the importer in conducting the business through a separate subsidiary. Such a structure may enable the company to allocate risks, and thus liabilities, among separate entities. For example, one “importer” entity can be established to purchase LNG receiving terminal capacity, import the LNG into the US, and own the LNG while it is held in storage at the LNG receiving terminal, while a separate entity can be established to purchase the regasified natural gas, enter into gas transportation contracts, and sell the regasified natural gas to end users. The importer need not be a US entity, although there will often be good commercial reasons to establish such an onshore entity.

The type of entity selected — for example, a corporation or partnership — and jurisdiction of formation also raise important tax issues. If the entity importing the LNG into the US is an offshore entity, then tax treaties between the US and the jurisdiction where the entity is formed may deter- mine whether the entity’s activities are subject to US taxation. Typically, where a non-US company undertakes all of the activities related to the importation and sale of the LNG without these activities being “attributable” to a permanent establishment in the US, it should not be subject to US federal income tax on the income from the LNG sales or importing business.

Various taxes, duties and fees may apply in connection with the importation of LNG into the US, including US customs and border protection duties on imported LNG, US customs reporting and documentation requirements and US customs bond requirements. In addition, a US customs broker’s power of attorney must be given. There may be additional fees payable to US customs. There may also be state taxes or fees for port or harbor use, as well as tonnage tax assessments, pilotage costs and harbor tug and other assist-vessel charges.

Before importing LNG into the US, the importer should review US customs requirements for importing LNG into the US. Moreover, it is important to understand any rules, regulations, fees and expenses that a port authority may apply or impose on LNG vessels berthing at a particular port.

Regulation

The federal government regulates both the importation of LNG into the US and the siting, construction, expansion and operation of LNG receiving terminals. The federal government’s regulatory authority is found in section 3 of the Natural Gas Act.

Any entity seeking to construct an LNG receiving terminal located on shore or in state waters must get approval from the Federal Energy Regulatory Commission. FERC will not regulate the commercial terms of service, such as rates that will be offered at a proposed LNG receiving terminal. Thus, new LNG receiving terminal owners and their users are free to negotiate terminal use agreements without regulatory oversight.

As a result of the recent Energy Policy Act, FERC has exclusive authority over the siting, construction, expansion, and operation of LNG receiving terminals. Despite FERC’s exclusive jurisdiction, interested state and local agencies may participate in any FERC proceeding in which the construction of an LNG receiving terminal is at issue. Moreover, state governments still have authority to act under certain federal environmental laws. The process for obtaining authority to construct an LNG terminal will take at least a year. FERC is implementing a prefiling procedure that is supposed to streamline the process.

FERC considers environmental issues as part of its permitting process. FERC takes the lead in evaluating the potential environmental and safety impacts under the National Environmental Policy Act and incorporates the minimum safety standards of the US Department of Transportation.

Section 3 of the Natural Gas Act also requires the LNG importer, as opposed to the LNG receiving terminal owner (if different), to obtain from the US Department of Energy authorization to import LNG into the U.S. The importer may be a joint stock company, partnership, association, business trust or organized group of persons, whether incorporated or not. The importer does not need to be a US entity to obtain DOE import authorization. DOE issues import permits in a relatively short period of time.

An LNG importer that plans to market the regasified natural gas may need to enter into gas pipeline transportation agreements with one or more interstate pipelines to transport its natural gas to end-users spread throughout the US. FERC has jurisdiction under the Natural Gas Act over transportation (which includes storage) of natural gas in interstate commerce. Unlike with LNG receiving terminals, FERC regulatory oversight includes jurisdiction over the rates and terms of service for interstate transportation and storage service. These terms of service are typically found in tariffs that are on file with, and have been approved by, FERC. The pipeline company and its customers are bound through individual contracts that incorporate the tariff terms. If the contract is materially consistent with the contract form that FERC has pre-approved, no further FERC approval is required. The Natural Gas Act does not require the entity using interstate transportation or storage service to be a US entity.

FERC does not regulate the price of natural gas. However, the Energy Policy Act gives FERC the authority to take action against practices in connection with the sale or interstate transportation of natural gas that are manipulative or deceptive. The primary purpose of this new legislation was to prohibit certain activities that were undertaken by gas marketing companies at the beginning of the decade that threatened the transparency of the interstate gas markets. FERC has the authority to request information from market participants and seek imposition of criminal and civil penalties for violating its anti-manipulation rules. Thus, companies seeking to market natural gas in the US should be aware of these rules and prepared to provide information on their gas marketing activities if requested by FERC.

The US Commodity Futures Trading Commission also has regulatory oversight with respect to certain activities commonly connected with the natural gas market. The CFTC has jurisdiction over accounts, agreements and trans- actions involving contracts for sale of a commodity for future delivery, including natural gas, electricity and any other energy product traded or executed on or subject to the rules of a designated contract market, registered derivatives transaction execution facility, or any other board of trade, exchange or market described in the Commodities Exchange Act.

An LNG importer intending to market its commodity in the US may be subject to CFTC regulation, depending on the scope of its marketing activities, particularly if they involve trading in financial derivatives.

Contractual and Commercial Issues

There are significant differences between LNG and natural gas in respect of how they are bought and sold in the United States.

LNG historically has been sold pursuant to long-term contracts, often 15 to 20 years in duration. LNG buyers are required to make significant take-or-pay commitments. The LNG buyer must agree to take delivery of a significant portion of the annual quantity of LNG available for purchase (often 90% or more) or nevertheless pay for the minimum purchase quantity. Often, the price of LNG is tied to world oil prices. These long-term, take-or-pay contracts are necessary to justify the substantial capital commitment necessary to construct and operate LNG liquefaction projects. With oil the competing fuel in many markets, the use of an oil price index ensures that LNG is priced competitively with oil. Conversely, the US gas market has, over the last 10 to 15 years, been largely based on short-term contracts. Take-or- pay commitments often depend on the quantity of gas that a buyer nominates for delivery during a month, week or day. The price for gas is usually based on a spot market price that reflects the price of gas at a particular point on the interstate pipeline grid. This price may or may not reflect changes in world oil prices.

LNG importers must be prepared to manage the risks arising from these differences. For example, an LNG importer must be able to manage the risk arising from significant take-or-pay obligations under its LNG supply contract in a market that relies on short-term gas supply arrangements. Moreover, the LNG importer must be able to manage potential mismatches between the LNG price and the price at which gas will be sold in the US. These mismatches arise not only from differences in the basis for the price (i.e., an oil price forming the basis for the price of LNG and a US gas price based on natural gas prices in the US), but also the difference when the price for the commodity is determined. For example, the price of LNG will be determined when the cargo is delivered, while the price at which the regasified natural gas is sold will be determined at a later date.

Because LNG is lighter than air and possesses half the density of water, no residual environmental impact should result from a spill or release of LNG. The LNG, once it warms, would evaporate. Unlike an oil spill, there would be no contamination to remediate, and the super-cooled LNG would not move far from the vessel or terminal before becoming airborne. LNG is also believed not to be toxic or carcinogenic. In the absence of any threat of environmental contamination or harm to human health, the US environ- mental laws do not impose standards or requirements for managing this material, and remedial liability under such laws would be remote.

The US Coast Guard has established safety standards for the design and operation of commercial vessels in US territorial waters. Any vessel to be used for transporting LNG into the US would have to comply with these requirements as a prerequisite to being allowed into US territorial waters and harbors. This has typically not been a problem for LNG vessels, because they tend to be newer and well-constructed, for example, using double-hulled designs.