TECHNICAL CONSULTING
Merlin Associates are heavily involved in the Liquefied Natural Gas industry with engineering design and operational experience beginning in the early 1960s. We have provided engineering consulting services to most of the LNG industry participants at one time or another and, in addition, have been very active in providing third party project cost and schedule risk analysis to most of the LNG projects and additions from 1983 through 2001 primarily for use in obtaining project financing.

LNG projects are typically extremely capital intensive (US$ 5 - 15 billion); require a very long period of capital expenditure during the design, procurement, and construction phases (3 - 5 years) before there is any income; and due to their large size and complexity, are nearly always multi-participant projects. It is very common to use project financing for these projects since their large required investment exceeds the available internal financing of all but the very largest international energy companies.

Most large energy projects have a loan collateral basis that can be evaluated – the recoverable hydrocarbon reserves that will be produced by the project. Due to the very large investment and the large volume of energy reserves that will be processed by the typical LNG project, the project’s recoverable hydrocarbon reserve collateral cannot be considered liquid in the normal sense. This leads to a project without a prime source of loan collateral for project financing. In spite of this, it has become increasingly common since the mid-80’s for grass root, base load LNG plants and LNG plant expansion projects to obtain limited and even fully non-recourse project financing. The main source of comfort to the investing or financing participant is the firm long term LNG sales contract between sellers and buyers. Even the sales contract must be to buyers that are regarded as very financially sound companies. This type of exposure for both the equity participants and the international financing community requires very conservative project evaluation and risk analysis.

An LNG plant that is not complete and capable of meeting its sales contract requirements has essentially no value as an asset against the loan. The salvage value of even the best available gas processing technology installed in a very remote area is very low. The only loan value is essentially the sales revenue generated after the plant begins operation.

Although historically this has always been a problem for LNG projects, the problem has become critical since about 1980 for several reasons.

• The size (and cost) of a world-class base load LNG plant has dramatically increased since the industry began in the late 1960’s. This has been to take advantage of the economies of scale for larger facilities.
• The LNG facility is built of high cost critical new technology components that have tended to have the highest inflation rates.
• The LNG facility is constructed using mostly the highest skill level construction workers that are in short supply the world over, their wage rates have tended to increase with the greatest rate of acceleration.
• The LNG plant onstream time is critical to project economic return. Base load plants tend to be extremely conservative in providing redundant backup equipment and this philosophy became extreme during the 1980s.
• Newest proven technology and increased automation have been steadily implemented in LNG projects to reduce operating and maintenance costs as well as to improve onstream-operating factors. This has tended to increase initial capital investment.

For all these reasons, many of the LNG project participants have increasingly used outside third party technical consultants to evaluate project costs, technical risks, project schedule, and efficiency of design. Merlin Associates was, in fact, started to fulfill this demand. Merlin has been the technical consultant to the financing community on most LNG expansion and LNG base load grassroots projects built from 1984 through 2001. We have also provided similar services to several of the equity participants on the same projects during this period. Merlin has also provided consulting services for preliminary feasibility studies by several operating companies and LNG buyers during this period.

Merlin has been a leader in developing a consistent methodology for project technical, capital, and schedule risk analysis for LNG projects.

Merlin is fully experienced to evaluate the feedgas production, transmission, liquefaction, shipping, and import terminal segments of the LNG energy chain.

EVALUATION METHODOLOGY
Merlin is available for assistance to any or all of the various parties concerned with the project and can provide this assistance in several ways depending on the particular client’s needs. We have described two of the most common approaches used by Merlin below but have actually used many variations of these.

1. Review/Analysis Method
For small projects or those at an early stage of development, Merlin can provide a review of the appropriateness and adequacy of design for the proposed LNG facility and feedgas system components. This may or may not include review of the capital cost estimate and project schedule.

An independent estimate of capital costs can be prepared to verify the Sponsor’s and or Engineering, Procurement, Construction (EPC) contractor’s estimate. Most LNG projects complete a great deal of conceptual design before obtaining the final EPC contractor quotes – this amount of available engineering data, basis of design, and specifications allows very accurate "upper-limit" estimates to be developed prior to contractual commitment. As the fabrication, construction, installation, pre-commissioning, and commissioning proceed, Merlin can provide project monitoring in any or all areas of activity with prime responsibility being to raise an alarm at the first instance of potential serious variance in cost, quality, or schedule completion. Merlin also participates in completion and acceptance testing of the project.

Several aspects of the Risk Assessment Method discussed below can also be incorporated into this method where it is felt justified due to the degree of exposure.

2. Risk Assessment
Merlin has evaluated a number of projects utilizing rigorous, methodical risk assessment criteria, which has been developed by the Merlin Associates principals. Merlin assesses the likely outcome due to various failure scenarios of the project execution plan. The Sponsor and EPC contractor usually place emphasis on achieving on-time and under-cost completion and do not always provide contingency planning until a crisis develops. The project execution plan as agreed between Sponsor and EPC contractor is usually realistic for the specified assumptions but is probably neither optimistic nor overly pessimistic. It is most often described as a plan with a 50% probability of being achieved within budget and schedule – it also has a 50% probability of exceeding the cost estimate and not being completed on time if it has truly been developed with this philosophy.

In addition to cost and schedule variance, the other major project risk exposure is confidence in reliability and capacity of the project facility. Merlin has a unique history and reputation for providing unbiased, third party, independent technical risk analysis and standard project risk analysis. Technical risk analysis includes detailed review of the process technology, the specific hardware to be used, and the overall project implementation planning.

Merlin Associates will provide a set of risk criteria or a band of predicted outcomes. The basis of Merlin’s risk analysis is development of an independent capital cost estimate using Merlin’s own project schedule. Merlin develops a summary level project schedule utilizing only sufficient activities to determine project duration, critical path activities, and sufficient activities to allow detailed capital cost estimating. The summary level project schedule will typically have 200 - 400 activities depending on whether the full feedgas system is included or not. The Merlin summary level project schedule with the Merlin capital cost estimate predicts expenditure phasing on monthly and annual time periods.

The capital cost estimate developed from the project schedule analysis is the Merlin deterministic capital cost estimate. This detailed estimate is summarized to 30 - 50 major cost categories for probability analysis. Statistical probability analysis is done using Latin Hypercube random sampling of all the assigned probability distributions. We usually use triangular probability distributions and we do take into account the affects of cost/schedule variables that have internal dependencies with other cost/schedule variables. A typical probability analysis requires 1,000 iterations in order to produce smooth probability curves.

Although the full spectrum of project probabilities are developed, Merlin typically report the Mean non-exceedance probability data (usually similar to the project’s 50% probability data); the 75% non-exceedance probability data (sometimes called "Most Likely"); and the 95% non-exceedance probability data (often called the "Worst Case Scenario"). The 75% probability data is a prediction of project outcomes assuming industry average problems, engineering judgment of project costs for the site-specific location with average costs, and adjustment for known site-specific problems. The 95% probability data assumes that the known problems all happen and has some contingency for unknown general project contingency in key project areas.

The complete risk analysis method is justified for the financing community on all LNG grass roots and most expansion projects. It is frequently justified for many of the equity participants who often do not have internal technical expertise in LNG technology and an up-to-date database of LNG project costs. Use of a third party consultant jointly by the LNG sellers and buyers is useful to eliminate internal disagreements and can greatly assist in reaching agreement on the actual details of the final sales agreement. Most LNG projects are multi-participant projects where an independent third party used jointly by all parties can be very helpful in avoiding internal conflicts.

II. EVALUATION CRITERIA & SPECIFIC RISK ANALYSIS EXECUTION

Merlin Associates uses the basic premise that LNG base load project design and implementation should emphasize simplicity and proven design. It is necessary to continually implement the latest proven technology on LNG projects in order to minimize their capital and operational costs, but the technology should usually be imported from other gas processing industries after it has been proven. If technology can only be proven in an LNG facility, hopefully it will be first used in a smaller plant or a peak-shaving facility rather than a base load plant. The following major categories are evaluated in the typical risk analysis:

1. Technical Design Analysis
2. Project Management and Systems
3. Project Schedule
4. Estimated Capital Costs
   The Merlin estimate is normally within 10% of well defined and consistent project capital cost estimates and is developed using the Merlin proprietary LNG Liquefaction and LNG Import Terminal capital and operating cost estimators.
5. Operating and Maintenance Costs

III. MERLIN ASSOCIATES LNG PROJECT & STUDY EXPERIENCE
Merlin Associates is uniquely qualified as a small engineering consulting company with worldwide experience and perhaps the most complete, comprehensive and up to date database of project costs and implementation performance for the natural gas liquefaction industry. We have summarized the highlights of some of our major study assignments below.

1. Pre-Feasibility and Feasibility Studies
Merlin Associates has provided numerous studies of potential LNG export and import projects for clients who have just begun consideration of the project and wish to establish the size of the ball-field before making major expenditures with EPC contractors. The study includes developing preliminary basis of design criteria for the project, implementation schedule, study of alternative technology options, capital expenditure requirements and cash flow profiles, annual operating budgets, Sponsor manpower requirements, and EPC contractor manning requirements in the home office and at the site. A listing of major areas of uncertainty that should be addressed prior to beginning a full-fledged Front End Engineering Design effort often is provided with a priority ranking of potential project impact.

Several assignments have included developing process flow diagrams, plot plans, and complete process heat and material balances using state of the art process simulator programs.

2. Development of Financial Model
We have developed financial models covering all segments of the LNG chain providing economic analysis of the project for the Sponsors, financial institutions, and product Buyers.

3. Development of Project Cost Estimating Model for Competitive Projects
We have provided full economic analysis of potential competing projects for various clients. These studies have included establishing a basis of design for each segment of the competing projects, developing capital and operating costs of the projects, and using a rigorous financial model to provide competitive economic results into specified market locations.

4. Other LNG/Cryogenic Experience – Design, Operation, Projects & Studies
Merlin has similar experience in other natural gas, industrial gas, natural gas based fertilizer processes, and petrochemical facilities.

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