The LNG business is in a period of fundamental change as it moves from its traditional rigid structure to become a fully traded commodity. This period of change is happening during a time of considerable volume growth in the industry with LNG supply doubling by 2020, from 2016 levels; with growth expected to continue until at least 2030. This change is not without pain, like a child growing from the restrictions and rules set by its parents, but one thing is clear, the LNG business will grow in size and become commoditised - the question is by when?
The April 2019 Oxford Institute for Energy Studies paper ‘New Players New Models’ argued that the LNG business could reach a ‘Tipping Point’ once sufficient LNG cargoes are traded on a destination free and contractually flexible basis. At that point, the LNG market should have sufficient liquidity such that prices are set by the supply/demand of LNG itself i.e. LNG becomes a commodity in its own right. The industry body GIIGNL calculated that the volume of Pure Spot Trades (PST) has increased to 25 per cent of LNG traded in 2018 (compared to 20 per cent in 2017).
By 2020, with increased volumes of LNG available from US supply projects, it is expected that market liquidity will increase further. It is these US LNG cargoes, that do not have contractual destination restrictions, which are underpinning the growth of flexible LNG trading. In parallel, two other key activities are happening that are increasing the likelihood of the ‘tipping point’ being reached.
Firstly the volume of LNG traded by aggregators and traders is increasing as they act as intermediaries, securing LNG under long-term contracts or entering into long-term, tolling agreements, in both cases underpinning final investment decisions on new LNG capacity. This puts LNG cargoes into the hands of companies that understand LNG trading and see the value of the business and will, by definition, increase the volume of LNG traded under shorter-terms contracts.
Secondly, the use of JKM swaps contracts has increased dramatically giving an effective pricing tool to manage price exposures between the gas buy-side (Henry Hub) and sell-side (Asian spot) or, if sold on an oil price-related bring basis, traders can use the existing liquid Brent oil futures contract to manage price risk.
Source: OIES, ‘New Players New Models’, Ledesma, April 2019
A key indicator as to when this ‘Tipping Point’ has been met will be the lenders – when will they be happy to lend, and investors to invest, on the basis of the economics of a project and a hub-based LNG price level. Long-term financing either requires long-term volume offtake or capacity agreements signed with a creditworthy counterparty. Though the period of ‘long-term’ has fallen from 20 to 10-20 years, in a purely traded market. It is the market itself that gives the offtake guarantee, as the lender would have limited risk as the market itself means that there is no volume risk as the market is liquid enough that spot and short-term cargoes can be bought or sold at a ‘market level’. The LNG trading market is certainly not there yet and that is why LNG finance still needs to be underpinned by some long-term security.
LNG demand outlooks vary depending on the consultant, company or other organisations that have prepared it. In 2018, the global LNG trade was 314 million tonnes (430 Bcm). By 2030, the range of outlooks varies from 440 million tonnes to 580 million tonnes – a difference of nearly 50 per cent compared with the 2018 LNG supply level. It is likely that this additional volume will be sold under long-term contracts using a blend of oil indices, primarily oil-related for non-US LNG and Henry Hub related for non-US supply project. Some contracts may include an element of Asian Spot price (JKM) but until liquidity of the contract increases then it will be unlikely that lenders will advance money on a JKM pricing basis.
The question, therefore, is when will the market be sufficiently liquid such that long-term contracts are not required to support the financing of new LNG capacity. This is the ‘million-dollar question’. One would hope by 2030 that it would be liquid enough, although some commentators argue that it could be earlier, 2025, but I think that they may be too optimistic.
This and other LNG related subjects are being explored in more detail in the forthcoming Oxford Institute for Energy Studies Forum magazine that will be published on its website in September 2019.
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