INSIGHTS FROM AMPHORA
LNG at an inflection point – the importance of optimisation in the mid-term
Continuing Amphora’s series of articles on the fast-changing LNG marketplace, we look at mid-term prospects for the LNG market.
LNG prices have experienced enormous fluctuation in 2020. Prices have recovered since the Summer, with a 30% increase. There is optimism about longer term prospects. BP’s Energy Outlook 2020, launched in September, forecasts significant growth in LNG demand by the mid-2030s in two of its three main projected scenarios for change.
While long to medium-term forecasts for LNG are positive, focus on this year’s price volatility has partially obscured an important recent development. Increasing correlation of global pricing is emerging. And that correlation is led by US pricing.
In a CERAWeek Conversation, Charif Souki, Executive Chairman and Co-founder of Tellurian, highlights this trend: “The first lesson from this is the importance of American prices on a global basis. The fact that we’re not drilling with enough rigs in the US is forcing prices to go up in the US. Surprisingly, the same thing is happening in Asia. You’re seeing the Asian benchmarks very well correlated with US prices. It has only happened for the last few months so it's hard to say that there is a trend that has been established. But if it continues like this, you will see a better correlation on a longer term basis.”
Most canny market operators have known for some time that the US LNG market is the main price setter for the Asian and European markets. This is beginning to contribute to shifts in geopolitics. In India, Prime Minister Modi has recently stressed the importance of US LNG natural gas to the relationship between India and the US. In China, President Xi has stated its goal is to be carbon neutral by 2060. LNG will play a vital part.
Does that mean LNG becomes more like oil – becomes a traded commodity? Yes, but it’s going to take some time. I think at the moment you don't have a strong incentive to enter into long term contracts. The market is not evolved sufficiently where the financial instruments represent a big premium to the physical movement of the commodity. It’s going to take, I’d say, at least another five years to where we have a truly liquid, financially hedgeable market.
Charif Souki, Executive Chairman and Co-founder of Tellurian
LNG is increasingly behaving like a tradeable commodity and creating its own global market. LNG supply is very flexible and a fleet approaching 400 vessels carrying huge volumes of LNG may be redirected to someone paying a better price. As pricing models linked to Henry Hub and Brent have become unpredictable, there is growing reluctance to sign up to long-term contracts.
Tellurian’s Charif Souki says: “Does that mean LNG becomes more like oil – becomes a traded commodity? Yes, but it’s going to take some time. I think at the moment you don't have a strong incentive to enter into long term contracts. The market is not evolved sufficiently where the financial instruments represent a big premium to the physical movement of the commodity. It’s going to take, I’d say, at least another five years to where we have a truly liquid, financially hedgeable market.”
He adds, “If you are a small buyer, you will be happy in the spot market. If you are a significant buyer, you will need to secure your production and the only way to do this is to make sure that you are represented in the whole value chain from the resource itself to the liquefaction capacity, including the transportation from one to the other.”
Predictions that LNG will evolve into a trading market in the mid-term, around five years, rather than in the short term, arise because of the lead time of LNG projects. Recently, the number of major LNG projects commenced has not increased dramatically. Finance for projects is restricted, in part because of the complexity and volatility of the market.
The oil majors who financed these mega projects off their own once healthy balance sheets in the past are proceeding much more cautiously in the current macro-economic environment. With such funding sources now no longer available, how does this affect the future of new projects?
Typical large-scale investment vehicles need to see security in their cashflow modelling. Without long-term buy-side commitment, it is difficult to envisage any projects that would secure long-term financing. The upshot is that in the early 2020s there will be a squeeze on supply and a steady upswing in the global LNG benchmark, which is evidently a proxy to the Henry Hub index.
Larger buyers are arguably better off now looking past the myriad of spot contracts and securing themselves longer term deals. Partnerships are being sought now by energy majors with these major buyers, thus securing future supplies at competitive prices to other sources of energy.
The air that we breathe
While market uncertainties may be putting the brakes on LNG, there are also accelerating forces. Major economies around the world are keen to drive down pollution that is impacting the health of their citizens. LNG is a greenhouse gas, so while it does not support the Green agenda of minimising long-term climate change, it can help reduce environmental pollution that affects health today.
According to the WHO, “Indoor air pollution – generated largely by inefficient and poorly ventilated stoves burning biomass fuels such as wood, crop waste and dung, or coal – is responsible for the deaths of an estimated 1.6 million people annually.” There is activity in India and China to move away from coal and build the infrastructure to receive natural gas at the ports and transport it inland. Even Europe has renewed interest in replacing the remainder of their coal fired generation. That in part is due to Carbon Certificates nearing 30 Eur/Tonne this Autumn.
The pressure on margins created by increasing global price correlation is driving industry players to squeeze every last drop of value from trading and financing processes, starting by minimising costs and getting the best price for cargos. Forging new trading partnerships and building new lines of trade finance is key so that players can be responsive to market changes. The Oxford Institute for Energy Studies (OIES) highlights that one of the most well-known of these joint ventures is JERA Global Markets, bringing together access to the world’s largest LNG demand portfolio from JERA (itself a joint venture owned by TEPCO and Chubu Electric Power) and EDF’s trading, risk management and optimization capabilities.
Winning competitive advantage
OIES’ October 2020 Insight ‘LNG Portfolio Optimization’ concludes, “As global gas markets liberalize and converge, traditional arbitrage margins will be likely to decline and profitability will be driven by efficient management of portfolios. LNG is often seen as the ‘bridging fuel’ both connecting geographically distant markets and playing a key role in facilitating the energy transition to low or zero carbon economies. However, it has a high cost of production and investment threshold and, in the current environment, LNG players need to maintain their competitive advantage.”
Business models are evolving and new partnerships and sources of finances are coming onstream all the time. At the same time technology is evolving, tapping into near real-time data on pricing and logistics. With a clear view of the global supply chain, players are better able to respond to change and plan ahead to win competitive advantage.
In a market with price fluctuations and oversupply, it is challenging to maintain revenues and manage credit risk management. A single view of the commodity supply chain is vital.
Amphora is a unique provider in today's LNG marketplace. We offer CTRM and Shipping services under one roof, allowing LNG clients to go to market quicker and for a significantly lower cost. For more information, please visit amphora.net.
In October 2020 Amphora set up a strategic partnership with nGenue, the market leader in Natural Gas ETRM and retail operations software. Together, Amphora and nGenue streamline LNG and Natural Gas operations, equipping businesses with operational solutions for US natural gas sales, marketing, pipeline scheduling, liquefaction, international trading, and shipping. For more information please visit ngenue.com.
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