Market Development
Historically, LNG has been traded point to point between large suppliers holding strong positions and selling through long-term take-or-pay contracts over pipeline infrastructure that connected suppliers with buyers. Buyers were willing to take on rigid contracts, often having unfavorable terms to have a supply of LNG guaranteed. A lack of pricing benchmarks also resulted in LNG prices being tied to the price of crude oil.
The shipping of LNG has provided enormous flexibility compared with pipeline delivered gas with markets focusing on large credit-worthy participants capable of committing significant capital expenditure needed to finance the necessary high-cost import/export terminal infrastructure needed.
Opportunities for smaller players to participate in the LNG trade are emerging within the diverse market, and the interaction of technology and commerce are driving innovation, creating breakthroughs that could pave the way to the development of new markets for both small- and large-scale LNG players.
The size of the LNG market has more than doubled since 2011, with annual growth being over ten percent over each of the past three years. LNG supply capacity also continues to grow rapidly through new large-scale liquefaction plants in Australia and the USA.
The increase in LNG production and growth in shipping capacity is forging dynamic relationships between buyers and sellers and creating new trading patterns that are being enabled by establishing several global gas supply hubs and gas-on-gas trading mechanisms.
In order to adapt to new market conditions, especially during these unprecedented times, commercial models and contracts are becoming more sophisticated and diversified in order to meet the needs of the global market.
LNG Trading
Shipping is the primary enabler for trading LNG between continents, and the price of LNG has experienced a high degree of volatility since plummeting in 2014, and later due to the COVID-19 pandemic. There are several variables at play, including the increased liquefaction capacity from USA and Australia, the liberalization of gas markets, oil & gas tariffs between China & USA, lack of cooperation between Russia and OPEC, and the outbreak of COVID-19.
Liquidity is key to development and the evolution of the natural gas benchmarks. A common way that traders operate a position on natural gas is with a futures contract that requires the trader to deliver a specified volume of natural gas to the buyer by an agreed date and price.
Having liquid and global benchmarks within a volatile commercial environment have driven market players to adopt hedging mechanisms to mitigate their own respective contractual risk. Large scale LNG projects require huge feed gas volumes and high cost infrastructure for liquefaction, storage and transportation. National Oil Companies (NOCs) and the larger Integrated Oil Companies (IOCs), commonly form joint venture partnerships in order to finance the enormous investments needed to bring such projects to life.
LNG Pricing
The LNG market's increased liquidity has created the opportunity to develop benchmarks in the pricing of LNG similar in principle to Brent and West Texas Crude benchmarks used for the price of oil.
A financial market is essential for establishing a liquid and flexible commodity market. Just as the more significant players have been able to mitigate risk through diversified portfolios of physical assets, an electronic financial market can enable the smaller players to do the same. Only, rather than operating with physical assets, they trade natural gas derivatives on electronic trading hubs.
Pricing hubs are being used to determine the price of LNG. For natural gas, the Henry Hub has been most prominent globally with others such JKM (Japan Korea Marker) used primarily for contracts in Japan, South Korea, China and Taiwan, TTF (Title Transfer Facility), and the NBP (National Balancing Point) for Europe and UK.
As LNG globalization progresses, and new hubs emerge, fundamentals will determine which of the hubs across Asia, Europe, and the USA achieve and maintain its benchmark status.
Portfolio Players
LNG portfolio players are companies that hold a portfolio of LNG supply from different regions as well as various shipping, storage, and regasification assets. By optimizing their supply and infrastructure, portfolio players can participate in short- and medium-term markets more efficiently than the traditional point-to-point arrangements that dominated the LNG business for decades.
Portfolio players use different strategies to take advantage of short-term opportunities, even though they operate within short and long term contracts that have been used by major energy companies that have the scale and financial capacity to take advantage of these complex activities and opportunities.
In the natural gas industry, hedging has typically been achieved by establishing a diversified portfolio of assets throughout the value chain and across multiple regions by owning assets and holding stakes within production, liquefaction, shipping, and marketing.
LNG projects are being expedited to the final investment decision stage by utilizing, in many cases, portfolios to manage excess LNG production, as buyers increasingly favor short-term and spot contracts.
The growing number of buyers & sellers within the global LNG market will require future players to adapt to wide-ranging customers' needs and offer flexibility in financing, supply, and delivery options.
Commercial flexibility and implementing new technology in processing, storing, and delivering LNG should allow the smaller players to take advantage of new markets while large scale players could also consider augmenting their existing operations and offer smaller breakbulk cargoes.
Hedging Risk
There are two elements involved in LNG trading, one being physical and the other being financial. The physical trade is the traditional purchase of a volume of gas at a predetermined price and delivered to its destination by a specified date.
In a financial trade, transactions taking place are on a digital platform where participating companies can place their bids and transact within a public domain.
A natural gas company can mitigate their financial risk by hedging, whereby they shift their risk over to another party with a different risk profile, often being a trader or upstream company. This may be achieved by taking a financial instrument position (monetary contract) between parties, similar to the company's physical exposure within the physical market. Hedging may be in the form of securities such as fixed forwards, swaps, futures, and options.
Since the price for natural gas in physical and financial markets have a strong correlation, hedging has been effective in reducing exposure to financial risk.
There are two broad types of hedging transactions being the over-the-counter and exchange-traded transactions. Large market players often utilize both; however, a case-by-case decision is generally based on liquidity, lender terms, equity provider conditions, and risk profiles.
An over-the-counter transaction is a bilateral contract whereby two parties agree as to how a particular trade or agreement is to be settled in the future. However, this can lead to a more complex transaction in contrast to an exchange-traded transaction being a standardized instrument that offers a narrow range of contract terms. Exchange-traded transactions are generally easier to trade; however, they offer some shortcomings when it comes to hedging.
Impact of US Produced Shale Gas
Hydraulic fracking has been used for over fifty years to extract locked in oil and gas deposits from underground shale formations. With significant leaps in the refinement of the process during the late nineties, fracking has enabled the USA to extract its reserves of natural gas, turning the nation from importer to a significant LNG exporter.
The USA accounted for over half of the new global liquefaction capacity during 2019, with the significant exports shipped to Japan, Spain, Mexico, UK, and France. The question arises whether this assumption is still valid under the current market conditions as a consequence of COVID-19.
The American region evolved as a liberalized market, based on gas being distributed over a domestic and international pipeline network that included Canada and Mexico, with pricing mechanisms based on Gas-On-Gas competition and indexed to the Henry Hub.
A Faster Road to Market
Spot and short-term LNG trades are multiplying, accounting for almost 40% of import cargoes over the previous 12 months. With the current oversupply of LNG and with prices under pressure, there is little doubt that spot cargo will only increase for export.
Seizing the opportunities that emerge within the changing market will require agility to respond, requiring creative solutions, faster decision-making, and projects completed against relatively short timelines.
A regular obstacle that often prevents small- scale LNG projects from proceeding is the capital cost and long lead-time involved in the construction of the marine loading terminal.
A fixed, permanently installed marine terminal is generally slowed by long permitting delays, environmental impact issues, and site-related construction constraints. The overall capital cost and time to completion often render medium and smaller-scale projects commercially unviable.
Floating Storage & Regasification Units (FSRU) have grown significantly since the turn of the millennium, with approximately 24 vessels currently operating as receiving terminals. The major drivers have been 50-60% cost saving and roughly half the time to construct an FSRU compared with a fixed terminal.
The emergence of the floating jettyless IQuay designed by ECONNECT Energy AS in Norway represents the next wave in floating facility implementation due to the breakthroughs in floating cryogenic transfer, stabilized platform technology, and rope-less mooring systems.
Interplay of Commerce & Technology
As already described above, commercially, the development of hubs within the LNG market is providing the means to balance risk across the market. It provides intermediaries' means to offer financial services such as brokerage plus the funding of cargos, power plants, processing, and loading infrastructure, thereby providing flexible solutions and cleaner energy into the global energy mix.
The interaction between technology and commerce is often the driver for innovation and breakthroughs, turning "yesterday's" commercially unviable project to tomorrow's opportunity. By using ECONNECT Energy's floating terminal technology, the cost, and reduced lead time benefits enables projects to proceed.
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