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TRENDS AND DEVELOPMENTS IN
LNG MARKETS & MARKETING: Adjusting Contracts to Fit a Shifting Market
Daniel R. Rogers Partner
King & Spalding LLP Houston
© King & Spalding 2017
Agenda
• Today’s LNG market
• What do today’s LNG Buyers want?
• Trends in LNG marketing & impacts on contracting
• The changing LNG SPA
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Shifting tides?
• While today’s buyer’s market condition is a product of the present “supply overhang”, many analysts project that LNG supply and demand will come back into balance sometime between 2021-2023
• In the meantime, pricing shifts in the relevant oil and natural gas market price indexes may begin to change the market dynamic somewhat on a bit earlier timeline
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Market impact conclusions • Regardless of whether oil prices remain flat or gradually
escalate from US$55/bbl to US$80/bbl over the next 10+ years,
– it seems plausible that U.S. Henry Hub pricing is likely to continue to rise, and
– a US$4.00-5.00/mmBtu HH pricing level is possible in the near-term
• Higher HH prices will begin to erode some of the “pricing advantage” that theoretical U.S.-origin LNG supplies would have enjoyed over the past few years
– Asian buyers that were dead-set on moving to HH pricing 5 years ago will continue to re-think their pricing strategies
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Market impact conclusions (cont’d)
• Even though we may be moving toward more global LNG supply-demand balance over the next 5 years (with corresponding LNG price increases), many North American export projects still may not be seen as being as competitive as they were viewed 3-4 years ago
• U.S. HH feed gas cost increases may offset or even exceed the significant liquefaction cost improvements that we may see with some of the new liquefaction technologies and improved construction methods
• The “next wave” of North American LNG producers will need to significantly bring down the cost of liquefaction in order to maintain a competitive foothold in the global marketplace
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1. Many buyers want shorter-term contracts
• Recent McKinsey & Company survey of LNG buyers & industry experts:
– Significant shift towards shorter term sales contracts
• Average length of a term contract signed in 2015 was just 8 years, compared to 15 years in 2008.
– Trend is likely to continue
• McKinsey survey suggests that more than half of LNG buyers expect their next LNG term contract to be a 5-9 year deal
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2. Many buyers are not interested in contract renewals
– McKinsey survey also found a reduced likelihood that buyers will renew their existing term contracts
• 2/3 of buyers with existing contracts reported that the chances of renewing those contracts were either ‘somewhat unlikely’ or just ‘possible’.
• The most significant reason for this was that the supplier was not felt to be price competitive (38 out of a possible 100 points)
• Supplier under-performance and inability to guarantee future volumes were also important, (accounting for nearly 27 out of a possible 100 points.)
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Source: McKinsey & Company (Energy Insights, January 2017)
3. Long-term buyers want very low pricing
• Today’s spot LNG prices are lower than many Buyers’ long-term contract prices – Some Buyers seem to be happy buying additional quantities on the spot
market rather than committing to longer-term contracts
• Buyers now have actual “gas-on-gas” pricing competition with the introduction of significant US HH-indexed supplies
• With oil prices in the US$50+/bbl range (Brent), traditional oil-linked Asian contract prices are very competitive with present US HH-linked supply pricing
• Some Buyers are now pushing down “slopes” in oil-linked pricing formulas
• Today’s low LNG and gas prices and gas-on-gas competition may further open the door to new emerging market Buyers
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Oil-indexed LNG Pricing
• Typical Asian market LNG contract price formula:
CP (in US$/mmBtu) = [0.1485 x JCC (in US$/bbl)] + ß
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JCC / Brent oil price slope
@ oil = US$50 / bbl
@ oil = US$100 / bbl
0.1485 x JCC [Traditional Asian oil-indexed pricing slope]
US$ 7.425 / mmBtu
US$ 14.85 / mmBtu
0.1335 x Brent [QatarGas – Pakistan State Oil Company Limited slope]
US$ 6.675 / mmBtu
US$ 13.35 / mmBtu
0.1267 x Brent [RasGas – Petronet LNG Limited slope]
US$ 6.335 / mmBtu
US$ 12.67 / mmBtu
Further downward pressure on oil price index slopes
• Latest 15 year term Pakistan supply tender:
– Eni – 12.29% x Brent
– Shell – 12.599% x Brent
– Gunvor – 12.7% x Brent
– Petronas – 12.9% x Brent
– Trafigura – 13.3699% x Brent
• Latest 5 year term Pakistan supply tender: – Gunvor – 11.6247% x Brent
– Eni – 12.29% x Brent
– Shell – 12.3% x Brent
– Engie - 12.39% x Brent
– Gazprom - 12.4700% x Brent
– Trafigura - 12.4874% x Brent
– CNOOC - 12.8280% x Brent
– Petronas - 12.900% x Brent
– Gas Natural – 13.29% x Brent
– Glencore – 14.4865% x Brent
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U.S. HH-indexed LNG pricing
• Representative U.S. Gulf Coast (FOB) pricing :
–Brownfield (conversion) facility:
• 115% x HH + US$2.25-3.00
–Greenfield facility:
• 115% x HH + US$3.50
• At today’s HH price of US$3.26/mmBtu, this equates to an FOB LNG price of US$6.00-6.75 per mmBtu
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4. Buyers want more quantity flexibility
• Upward Quantity Tolerance (UQT)
– Typical limits
– Timing of exercise
• Downward Quantity Tolerance (DQT)
– Typical limits
– Timing of exercise
• Cargo cancellation rights
• Back-end “ramp-down” rights
• Call option structure
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5. Buyers want more cargo destination flexibility
• Destination restrictions
– Historical rationale for destination restrictions
– European Commission competition laws
– Easing of destination restrictions
• Today’s market:
– Destination flexibility in DAT deals – geographic area limits, “same or shorter distance” limits or unlimited range?
– Vessel-terminal compatibility issues (in DAT deals)
– Incremental shipping costs (in DAT deals)
– Which party may request (in DAT deals)?
– Economic “upside” sharing (in both FOB and DAT deals)
– Timing for request (in both FOB and DAT deals)
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6. Some buyers want seasonal delivery schedules
• Typical contract language:
– LNG to be made available for delivery from Seller to Buyer “shall be at rates and intervals and in quantities reasonably equal and ratable throughout each Contract Year . . .” (emphasis added)
• Today’s market:
– Requests for a disproportionate quantity of the AACQ to be delivered in a defined 3-5 month season (typically winter)
– Issue: since a Seller-producer will produce LNG on a reasonably ratable basis throughout the year, seasonal deliveries put significant strains on its ability to market all of its production on a long-term basis
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7. Buyers want more expansive FM protection
• Many traditional LNG SPAs do not explicitly extend FM protection to the Buyer for facilities and customers downstream of the LNG receiving terminal
• Today’s market: some Buyers are pressing for explicit FM coverage for various downstream pipeline, power generation and industrial facilities in the Buyer’s end-market
• Issue: this exposes the Seller to risks that are well outside its ability to understand or mitigate
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Trends in LNG marketing and contracting: Emergence and impact of portfolio marketing and LNG commodities trading
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Portfolio Marketers • Who are they?
– LNG trading companies linked to their upstream LNG producing affiliates
– Shell Marketing & Trading, BP Gas Marketing Ltd., Total Gas Marketing, Cheniere Marketing, Petronas LNG Limited, etc.
• What do they do?
– Take/purchase equity LNG from one or more upstream LNG producer affiliates
– Will also buy LNG from other producers
• Spot and term
• Typically FOB (loading port) delivery terms
– On-sell LNG to third-party buyers on a spot & long-term basis, typically on DAT delivery terms
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Commodities traders • Who are they?
– Pure commodities trading entities: no affiliated upstream LNG production
– Gunvor, Trafigura, Vitol, Glencore, Mercuria, etc.
• What do they do?
– Purchase LNG supplies from multiple non-affiliated LNG producers/sellers
• Spot and term
• Typically purchased on FOB (loading port) delivery terms
– On-sell LNG to third-party buyers on a spot & long-term basis, typically on DAT delivery terms
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Portfolio marketers & commodities traders
• What is the impact on the LNG SPA?
– No fixed upstream facilities or dedicated reserves for supply
– Buyer must focus on financial credit & experience of Seller • No dedicated plant facility & reserves supporting contract
• Seller typically has a large number of customer relationships to manage
• ADP will typically identify plant and vessels, but may vary from cargo to cargo
– Better ability of Seller to mitigate supply interruptions
– Seller might better accommodate Buyer’s seasonality requests
– Need for closer monitoring of credit & performance risks
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Portfolio marketers & commodities traders
• What is the impact on the LNG SPA? (continued)
– Cargo-by-cargo seller shortfall / buyer deficiency regime
• Differs significantly from traditional take-or-pay (TOP)
• Parties’ delivery & receipt obligations are measured on a “real-time” basis
– Buyer’s and Seller’s performance failures are settled as and when they occur, instead of accumulating into year-end TOP invoice or Seller Shortfall invoice
– Buyer typically pays in full for missed cargo and receives a credit from Seller’s re-sale proceeds
» increased focus on Seller’s mitigation re-sale obligations & transparency of re-sale pricing
– Potentially lower payment security needed from Buyer
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Portfolio marketers & commodities traders
• What is the impact on the LNG SPA? (continued)
– FM risks and handling are very different
• Typically a more cargo-by-cargo approach, with main focus on loading terminal and ship named in the ADP/90 Day Schedule
• Issue re whether events affecting upstream gas reserves or delivery pipelines should be covered
• Complicated issues flowing from allocation / spreading of FM risks across multiple supply sources in any single Contract Year
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Portfolio marketers & commodities traders
• What is the impact on the LNG SPA? (continued)
– Greater shipping & cargo size flexibility
• Need to address potential for Seller’s “out of fleet” supply and delivery opportunities
• Puts more pressure on Buyer’s inventory management
– Potentially greater scheduling flexibility
• Potential for Buyer cargo diversions and cancellations within the 90 Day Schedule
– Potentially broader GHV specification range from multiple supply sources
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Chambers Quotes on K&S LNG Team: • “They have a very specialised knowledge that most firms don't have, particularly on LNG
projects.” Chambers Global 2016
• “They are very creative and willing to chat through unique and challenging circumstances without preconceived notions of how to solve issues.” Chambers USA 2016
• “Considering the many millions of dollars that we save our company with their help, their value far exceeds the money that we pay for them.” Chambers USA 2015
• “Very hands-on and incredibly responsive, they assign the right people at the right value level for what needs to be done. They are fast and give the right advice.” Chambers USA 2015
• “Respected project finance group that focuses on advising sponsor clients on the development and financing of oil and gas infrastructure.” Chambers USA 2015
• “Exceptional expertise in LNG matters and frequently sought out to play a leading role on some of the largest mandates worldwide.” Chambers Global 2015
• “They are very strong in LNG.” Chambers Global 2015
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