LNG: a fungible tangible
A shift away from big-budget projects to smaller-scale plants will fundamentally change the market
IT RIVALS iron ore as the world's second-biggest traded commodity - after oil - yet the liquefied natural gas trade remains opaque and illiquid. This is about to change, irking the supermajors that have monopolised the long-term point-to-point business for decades. LNG is coming of age as a commodity.
Producers, who feared any change in the business model would lead to a drop in prices, have always resisted this. They insisted long-term oil-linked contracts were still needed to offset their huge investments in LNG. Only a year or so ago, Shell, ExxonMobil, Total, Chevron and BP, along with their national oil company (NOC) partners, controlled more than 95% of all LNG supply. A study by the International Energy Agency showed that of 28 LNG complexes, only three did not involve a supermajor or NOC.
But this supermajor-only development model is changing, and with it the market for trading LNG. Over the next two years, of all the schemes hoping to take a final investment decision, only two (ExxonMobil's PNG LNG and Eni's Coral floating LNG in Mozambique) involve supermajors or NOCs. Typically, the only new projects that will be competitive in future will be low-cost small- and mid-scale plants.
All in the detail
Historically, the big exporters refused to let importers resell or redirect contracted LNG cargoes - an attempt to stop customers competing against producers in an exclusive game. But faced with a fiercely competitive, oversupplied market, that too is changing. Sellers have to be more flexible - both on pricing and allowing customers to freely trade their cargoes. Driving this momentous shift is the imminent surge in global supplies from Australia and the US. The new American export industry broke the mould - it offers transparent pricing, tolling opportunities, gas-based indexation, shorter contracts, as well as freedom to resell.
Sellers have to be more flexible - both on pricing and allowing customers to freely trade their cargoes
At the same time, demand growth is wavering. With so much homeless supply - flexible LNG will make up 25% of expected volumes by 2025 - very few buyers are signing long-term sales deals. Some are even trying to renege long-term commitments.
In fact, in Asia, which swallows two-thirds of global LNG, contracted supply will peak in 2019. As long-term deals start to expire, contracted volumes are forecast to fall by 10m tonnes a year (t/y) - a major source of uncertainty for the market. Asian importers have strongly voiced their demands for shorter and more flexible supply contracts with more transparent pricing. On the back of weaker-than-expected demand a lot of end-users in Asia cannot take their contracted volumes and are already pushing cargoes back out to the market.
Over the past year, traders, also known as portfolio players, have beefed up their market presence, bolstering the number of active suppliers in the game for short-term delivery. Moreover, this comes at a time when fully flexible US LNG cargoes enter the market. The combination of an oversupplied market and increased flexibility is expected to improve the arbitrage opportunities, which will see regional gas prices converge further.
This fusion of oversupply and more flexible cargoes will also underpin the long-awaited Asian LNG hub. On top of the established spot-price markers and indices for Asian LNG, the Singapore Exchange launched a weekly LNG price marker named after the country's national cocktail, the SLiNG. Derivatives from this benchmark, which refers to cargoes in the region - half the Asian LNG trade passes the island state - were launched in January. Despite its miniscule gas market, Singapore is pushing to become the regional LNG hub, with more than 20 trading desks already setting up shop. Shanghai and Tokyo have similar ambitions. Tokyo-based CME Group is banking on a Japan-focused LNG futures contract, which started trading in March.
But there will be hurdles to overcome. First, traded markets need to become deeper, with a mix of piped gas and LNG, to provide more reliable prices. Asia, in particular, lacks infrastructure and international interconnections. Second, derivatives markets are needed to allow producers to hedge against price swings when investing in expensive new capacity. Third, end-users must deregulate energy markets to encourage competition for the best sources of supply. These, too, are uncommon in Asia. Japan is only just starting to liberalise its electricity and gas markets, while South Korea, the world's second biggest LNG buyer, will follow later.
Yuji Kakimi, president of Tokyo-based Jera, which was formed by Japanese utilities Tepco and Chubu Electric in late 2015 to pool their clout in securing LNG, reckons a more fluid Asia-specific LNG pricing market will emerge over the next decade. It will have measurable liquidity, while transactions, regardless of scale or stakeholder interests, will be transparent in their pricing, predicts Kakimi. Jera, which has 40m t/y of LNG on its trading books (making it the largest buyer globally), is looking to join forces with South Korea's Kogas and China's Cnooc. The potential alliance accounted for one-third of global LNG sales last year. That should give the newly merged Shell-BG, the undisputed privately-owned leader in LNG, something to think about.
For now LNG is still sold too inflexibly, except for a small, albeit expanding, market of spot cargoes. Prompt spot trades made up only about 6% of total LNG sold in 2015. But the more optimistic estimates see spot sales making up as much as 30-50% of the market by 2020. Coal, LNG's biggest competitor in Asia, is sold much more flexibly, not to mention cheaply. LNG has not caught up with the black stuff yet. More flexible trading arrangements, making LNG a commodity not just in name, will help it do so.
This article is part of an in-depth series on offshore production. Next article: Power to the buyers.