LNG contract volumes see sharp rise
Covid disruptions prove no barrier to major year-on-year jump in H1 2020
LNG contracting during the past six months has defied many expectations to soar compared with the same period in 2019. At least 24 contracts covering nearly 24mn t/yr have been signed, compared with just 14 contracts for 13.1mn t/yr during the first half of 2019.
Even more surprising, most of the contracts involved sellers who were not sponsoring new projects. Buyers signed 16 contracts for 12.23mn t/yr with aggregators, traders and producers with legacy plants where long-term contracts have expired. The average length of these contracts was for six years and the average volume was just over 750,000t/yr.
In addition, eight contracts for 11.75mn t/yr were inked by new project sellers in Mexico, the US, Nigeria and Mauritania/Senegal. These contracts’ average length was longer, at 15 years, at a doubled average volume of just under 1.5mn t/yr.
Contract negotiations did initially slow dramatically as economies around the world were locked down in February, March and April. However, as time went on, many buyers and sellers were able to resume discussions and eventually were able to make progress toward new deals.
For buyers, there is a pervasive view that the current weak markets and the uncertain outlook for prices make this an ideal time to negotiate for new supply. Sponsors of new projects are eager to cut deals that will enable them to advance their projects. And holders of tons from expired contracts are also highly motivated to find homes for their volumes as well as willing to sell at attractive prices because they have repaid their original project finance loans. Buyers are also aware that, unless they commit to some projects now, they could risk struggling to find future supply as capacity build-outs will slow.
24mn t/yr – LNG contracts signed in H1 2020
Producers share some of a similar outlook. A large pool of projects, particularly in the US but also globally, are competing for a limited number of potential buyers. So there are strong incentives for project sponsors to take the best deal they can find now instead of holding out for higher prices.
Asia-Pacific is the most common destination in contracts that specify one, with 13 contracts signed for 8.3mn t/yr designated for East Asia. But seven contracts for 10.75mn t/yr did not indicate any intended destination. With one exception, these deals were all between traders or aggregators and project sponsors. They tended to be for longer duration—16 years on average–and for greater volumes—more than 1.5mn t/yr–than destination-specific deals, which averaged seven years and just over 750,000t/yr. Traders and aggregators continue to aggressively build supply portfolios, while end-users—mostly the buyers for destination-specific volumes—are more cautious and generally sign shorter, smaller deals.
The Atlantic Basin leads other regions as a supply source for the newly inked contracts, with seven contracts for 11.25mn t/yr. Nigerian production makes up c5.8mn t/yr of this total, with additional contracts from Algeria, Mauritania/Senegal and the US.
Another seven deals for 4.25mn t/yr were signed for Pacific Basin supply, although, interestingly, four of these were for North American supply—two each from US firm Sempra’s Energia Costa Azul project in Mexico and from Shell’s LNG Canada project in the Pacific Northwest. Three other deals were signed with Australian producers.
Qatar and Abu Dhabi signed five contracts with volume totalling 5.5mn t/yr. Portfolio deals without a specific supply source accounted for the remaining five agreements, with a volume of just under 3mn t/yr.
According to Poten & Partner’s latest contract price analysis tools, the average oil-linked slope has been falling steadily since 2014, when a typical deal was priced at 13.4pc of Brent crude. The average Brent slope for contracts signed in H1 2020 was 10.6pc, down slightly from a typical 11pc at the end of 2019.
There are strong incentives for project sponsors to take the best deal they can find now instead of holding out for higher prices
Another interesting finding of Poten’s new analytics is that tenders appear to be a far more advantageous approach for buying LNG than bilateral negotiations, at least for the contracts signed in H1 2020. Using the current forward curve to calculate the expected purchase cost of LNG indicates that companies that signed contracts so far this year after holding a buy tender would be expected to pay an average of $5/mn Btu during 2022. But firms that signed contracts after engaging in bilateral negotiations without a public tender would be expected to pay $5.92/mn Btu.
There are good reasons why bilateral deals might be showing higher prices. A bilateral approach might be required for more complex deals, which might have additional requirements that could push the price up, for example. Bilateral deals also averaged 11 years in duration compared with tenders, which tended to average about nine years. The shorter tenor of the tenders may have affected pricing. That said, it may be as simple as a tender’s competitive element prompting sellers to reduce offers in an effort to win new business.
The benchmarks used to price LNG has seen little innovation this year. Oil benchmarks still dominate—16 of 24 contracts for 17mn t/yr were priced against crude, almost all of them linked to Brent. Another seven contracts covering 6.2mn t/yr were priced against gas benchmarks, including US marker Henry Hub, Asian spot Index JKM and European gas hub TTF. One deal was fixed-price.
Market turmoil seemed to prompt most buyers and sellers to gravitate toward a known benchmark as a safer option. With around two-thirds of LNG market volume still priced against Brent, significant opposition to Brent pricing is lacking. US sellers still prefer Henry Hub as the cost of US gas, while European importers prefer TTF because it represents the value of alternative supply. But interest in new indices or more innovative pricing structures appear still to be largely on hold.
Jason Feer is head of business intelligence at Poten & Partners