Changing dynamics in LNG contracting strategy – A myth or reality?

Lennart Luten's picture
Lennart Luten, Director, Galway Group
Matthew Tan's picture
Matthew Tan, Managing Director, Galway Group - Singapore
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During the last quarter of 2014, ENGIE and Chubu Electric signed an HOA for the supply of 20 LNG cargoes, reportedly linked to Asian spot prices. The approximately 1.2 million tons of LNG is sourced from the ENGIE global supply portfolio. Widely considered as a pioneering move by a traditionally large but conservative buy-side LNG player, did this deal provide a sneak preview into changing LNG market dynamics and its impact on contracting strategies in the coming years?

The sudden and sustained drop in oil prices over the past 15 months has been a vivid reminder of the importance of managing exposure to LNG price risk, whether you are a buyer or seller. The jury is still out as to how many parties will try to invoke price reopener clauses or otherwise seek to resolve the implications of this ‘Black Swan’ event. Going forward, a natural response to this unprecedented occurrence would be for market parties to start considering more on hybrid pricing mechanisms (e.g. Henry Hub & Brent etc.) when exploring new LNG supply deals.

But the oil price upset happened at an arguably pivotal moment in time, adding an important element to the mix. Against the backdrop of already slower-than-expected, notably Asian, gas demand growth in combination with a surplus of available LNG supplies, buy-side players suddenly realized that the era of the long hailed buyers’ market had finally arrived.

The shifting balance of power has provided creditworthy buyers in particular – cognisant of the unpredictability in their own future gas demand profiles – with a unique opportunity to blend price demands with flexibility demands in their contract negotiations. And whilst eager sellers will be excused for trying to counter such demands with perfectly rational arguments on paper, the market is bound to see more FOB clauses, less on-selling restrictions, shorter contract terms, more hybrid and spot pricing indexation mechanisms and more closely defined price reopener clauses.

It is certain that the current dynamics will cause sellers to look even more seriously at managing their risk exposure, which is also the reason that cross-basin portfolio players are likely to be among the parties that will best be able to cope with the new reality. There are certainly opportunities for the suppliers. By offering new, dare we say, innovative contract terms, valuable trust can be gained and relations can be built with both traditional and new buyers, which will prove all too important when the tides are turning.

One thing is inevitable. New LNG liquefaction projects need to take FID to meet the growing gas demand. Despite recent market dynamics, the capital-intensive nature of the LNG industry is such that even 20 years down the road, the majority of liquefaction projects will still be significantly underpinned by medium- to long-term off-take contracts. The thought of purely merchant enterprises becoming common sight is simply not realistic.

How will contracting strategies change in the coming years? Share your insights below.

This article was originally prepared for Gastech 2015 and it has undergone slight modification to reflect actuality.

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