Opportunities and risks in the global LNG market
Natural gas use has strongly increased around the globe, supported by higher demand and growing availability of gas. As a result, a surge in LNG trading has been seen across the world, and there is no indication of it slowing anytime soon. According to BP’s 2018 Energy Outlook, LNG trade will account for around half of all globally traded gas in the next 17 yr alone.
Amid the opportunities that accompany LNG expansion, major challenges must be addressed. The complex trading cycle of LNG means that numerous processes and players must be considered, from natural gas suppliers and liquefaction plants to transport operators and storage facilities, to the financial processes that keep the cycle moving.
To overcome the associated market challenges, industry players must have the tools and capabilities to effectively manage risk while seizing opportunities for growth.
Responding to shifting contract structures. S&P Global Platts and other leading industry experts have projected that continued growth in global LNG exports will mean more competition in the market and, in turn, more short-term options for buyers who may decide to either renegotiate or completely do away with long-term contracts. Those that hold existing long-term contracts tend to respond to current oversupply conditions in one of two ways: rush to renegotiate pricing or fail to meet contractual commitments due to lack of demand. Regardless, both producers and buyers are consistently reconsidering and renegotiating their traditional sales and purchase agreements (SPAs).
Additionally, present industry conditions not only alter the structure of LNG contracts, but they also affect spot pricing and trade margins. As a result, the industry is experiencing a shift away from traditional producer/consumer relationships and moving toward a more competitive trading market. At present, market participants contract under an LNG master sales and purchase agreement (MSA), specifically intended for use with spot and short-term agreements. This structure allows the substantial flexibility necessary for the buyer and seller to customize the agreement to individual cases.
Due to this rise in short-term contracts, the number of participants in the LNG derivatives market has increased significantly. This increase enables enhanced optionality, as well as added long-term market exposure to bring yet another layer of complexity to global energy portfolio management.
For example, Indian gas utility GAIL has shifted its LNG purchasing focus to short-term and spot deals to meet rising demand, and it is making greater use of hedging against price volatility, according to Reuters. By responding to the market shift in this manner, the company is working to double its share of gas from the present level in the next decade. Other companies have followed suit, signaling an uphill battle for producers as lower spot prices for global oversupply will bring about more contract revisions.
Options leading to greater risk. The mobility of LNG cargoes and their ability to be diverted in response to price signals allows the gas market to become increasingly integrated. Charif Souki, Chairman at US LNG developer Tellurian Inc., claims that buyers are “never very far from a cargo,” and that in the next 2 yr, some 20 cargoes will be available every day on the spot market—equaling approximately 5,000 cargoes/yr.
However, with additional logistics options come challenges. For those in the energy market, increased trading and logistics options come with a price: increased risk exposure. Producers must now consider new transportation and storage options on top of operating expenses, raw materials processing costs and additional deductions that impact the bottom line.
Buyers, on the other hand, must consider the fact that recent LNG market changes have produced competitive pricing as more traders are taking proprietary positions and adding more depth to the market. In an instance where demand outweighs supply, for example, natural gas utilities and natural gas generators may find it possible to supplement their natural gas supplies with LNG imports. However, due to the increased complexity brought by additional available options and market competition, the tricky part for buyers is knowing when to purchase, how much to purchase and from whom they should purchase assets.
Creating opportunity through global exports. LNG exports from the US have already quadrupled in the last year. In the next 5 yr, exports are projected to increase enough to position the US as the number-two global supplier of LNG. BP’s Energy Outlook predicts that by 2040, US LNG exports could account for almost 25% of global gas production, ahead of both the Middle East and the Commonwealth of Independent States (CIS).
With the rapid increase in US participation in the expanding market, the balance of supply and demand around the globe has shifted drastically. As a result, traditional global supplier/customer relationships in this market are changing. With this shift in the global market comes vast opportunities, such as increased accessibility and synchronized prices. At the same time, the expanding US market adds even more complexity to the portfolio management of energy companies that sell and purchase on a global scale. A traditional domestic gas supplier will see LNG cash cycles lengthen due to the time and logistics required for global transportation. Throughout these cash cycles, energy companies must keep in mind the price fluctuations in natural gas, credit risk on foreign entities, currency exchanges and other factors when executing trades and managing assets. The ability to accurately track all of the aforementioned variables may seem impossible, and many large energy companies have still not mastered this ability.
The US Commodity Futures Trading Commission (CFTC) claims that the LNG business can be considered “an arbitrage between low domestic prices and high global prices,” despite its expensive nature. Due to rising gas production, domestic prices have fallen, and a competitive advantage has become available for US companies to export LNG to global buyers.
However, these increasing exports of LNG from the US also mean that global forces will have a greater impact on the country. With increased exports, domestic natural gas prices will come under greater pressure, thereby exposing the North American market to global market dynamics. As such, industry participants are expanding their businesses to gain efficiencies in logistics and operations to have more control over margins. With a greater presence in the LNG market comes a more complicated logistics chain and longer pay cycles, which results in more hedging and credit risk analysis capabilities that companies must prepare to address.
The need for an energy management platform. The already complex natural gas and LNG portfolio value chain has become even more complicated with the growth of the global market, increased market competition, oversupply and shifting contracts from long-term to spot or short-term agreements. Depending on how proactive industry participants are, these market changes can either provide businesses with growth opportunities or spell out a recipe for disaster. It is more important now than ever to prepare for drastic changes in portfolio management and supporting software infrastructures.
Industry players who do not respond adequately to market shifts or pursue strategic insights may be limited in their ability to correctly identify opportunities or potential challenges that must be overcome. As a result, decisions might be made without thorough historical information, real-time insights or forecasting, leading to increased risk exposure and missed growth opportunities.
To effectively manage portfolio risk and take advantage of opportunities created in a constantly evolving energy market, a company can take advantage of enterprise software platforms that not only provide real-time, full value chain management, but also advanced quantitative risk analytic capabilities. The use of a comprehensive commodity management software can address energy market opportunities and risks by integrating all physical and financial aspects to manage the entire LNG lifecycle. GP
Michael W. Hinton is the Chief Strategy and Customer Officer at Allegro Development Corp., a global leader in commodity trading and risk management software for companies that buy, sell, produce or consume commodities. Headquartered in Dallas, Texas, Allegro has offices in Houston, Jakarta, Singapore, Dubai, London and Zurich.