NrgEdge Staff

Editorial Support
Last Updated: May 31, 2016
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Gas & LNG

The dynamics of the LNG market are changing fast.There is more and more spot and short term trading, new players in theform of trading houses are coming to the market, new price benchmarks are beingintroduced and new financial instruments like futures and swaps becomeavailable for managing the price risks.

The current market is in a state of oversupply, asthere is a rising supply coming onto world markets from new exportingfacilities mainly from the U.S. and Australia.  As the demand in Asia,good for 70% of the global LNG demand, has failed to keep up with the risingsupply, LNG prices have sunk to a seven-year low in that geography.

The average spot price in Asia for LNG for delivery inMay dropped by 42.5% year-over-year to $4.241 per million British thermalunits, the lowest monthly average since July 2009, according to price reportingagency Platts.

The result of this cocktail of excess supply and lowmarket prices is that the main buyers from leading importing countries likeJapan and Korea move away from a single reliance on long term oil indexedcontracts to a much more flexible procurement portfolio also including shortterm and spot contracts. Already, sales of LNG on the spot market and viashort-term contracts lasting less than four years had risen to app. 30% oftrade in 2015 from 5.4% in 2000, and are likely to grow further. Pricereporting agencies claim that there are daily bids and offers for physical LNGcargoes.

This move away from long term contracts is bad newsfor the producers who  have invested billions into LNG plants and now seethat today’s LNG prices are insufficient to guarantee a proper return on theirinvestments. Still the major producers have been reluctant to cut output forfear of losing their market share, even if that means selling their products ata discount. Companies also cannot afford to curtail production atfacilities now coming on stream that have taken years and billions of dollarsof investment to start up.

Buyers are understandably more cost conscious and expectingthe price of LNG to reflect more adequately what is going on in themarketplace. For instance the worlds’ biggest buyer, Japanese JERA, now plansto buy LNG using contracts of varying length, and move away from using oil as apricing reference.

LNG buyers should go for a mix of different types ofpricing formulas in order to cover the various possibilities for the evolutionof the gas price and the oil price.

The main pricing benchmark so far in Asia is theso-called  “Japan Crude Cocktail” (JCC) that represents the average pricefor crude oil imports into Japan. The JCC index is used as a reference priceindex for long-term LNG contracts in Northeast Asia. As LNG prices declinedalong with crude oil prices in 2015, the JCC-indexed prices started to divergemarkedly from prices of physical LNG delivered into Japan.

 The last few years more LNG spot contracts havestarted to be priced off spot indexes. An estimated 40% of the spot andshort-term contracts are currently priced off the Platts JKM index. Efforts areunderway to develop alternative benchmarks to complement the Platts JKM.Recently the SGX, the Singapore Exchange launched the SLInG index and in Japanthey have launched the RIM Index. Both countries done this to support theirgoal of becoming the regional or global LNG Trading Hub. These indices are alsobenchmarks for LNG futures contracts that could be used for a hedge of spot LNGcontracts.  Although these financial contracts are hardly traded by theindustry so far.

 The US Henry Hub index is likely to become animportant pricing benchmark for LNG term contracts in Asia, as it isincreasingly being used by the US LNG exporters for deliveries into Japan andSouth Korea. The Henry Hub index is an existing benchmark for the US naturalgas market and also the underlying benchmark for the highly liquid natural gasfutures contract traded on the NYMEX.

 For the success of a futures contract the mainrequirements are a well-functioning underling cash market and enough potentialbuyers and sellers to create enough liquidity. Due to the fast growth of spotand short term trading based on one of the spot benchmarks, more and moremarket players are facing an exposure to LNG market prices and for the JCC tothe Brent oil prices that they would like to hedge away, if needed. Looking atthe players in the market there is a good diversity between those who have longand short term exposures to the LNG market.  Among the players  whohave physical positions that need to be hedged, the “Shorts” are typically theJapanese, South Korean and Taiwanese power and gas companies, and the “Longs”are typically project and infrastructure developers. Banks, trading houses likeGunvor, Vitol, Trafigura, Mercuria, etc. , financiers and LNG ship owners alsohave financial exposures to LNG prices.

 The Brent and Henry Hub Natural gas futures arehighly liquid and could therefore be used as a solid hedging instrument. Forthe futures based on the recently launched Asian spot indices the liquidity isstill very poor, although it is still early days, so these should be approachedwith a lot of caution.

It is certainly recommendable to inform and educateyour people about the use of financial instruments as part of your riskmanagement strategy. It would be my pleasure to share my unique expertise withyou and your people.

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In 2018, the United States consumed more energy than ever before

U.S. total energy consumption

Source: U.S. Energy Information Administration, Monthly Energy Review

Primary energy consumption in the United States reached a record high of 101.3 quadrillion British thermal units (Btu) in 2018, up 4% from 2017 and 0.3% above the previous record set in 2007. The increase in 2018 was the largest increase in energy consumption, in both absolute and percentage terms, since 2010.

Consumption of fossil fuels—petroleum, natural gas, and coal—grew by 4% in 2018 and accounted for 80% of U.S. total energy consumption. Natural gas consumption reached a record high, rising by 10% from 2017. This increase in natural gas, along with relatively smaller increases in the consumption of petroleum fuels, renewable energy, and nuclear electric power, more than offset a 4% decline in coal consumption.

U.S. total energy consumption

Source: U.S. Energy Information Administration, Monthly Energy Review

Petroleum consumption in the United States increased to 20.5 million barrels per day (b/d), or 37 quadrillion Btu in 2018, up nearly 500,000 b/d from 2017 and the highest level since 2007. Growth was driven primarily by increased use in the industrial sector, which grew by about 200,000 b/d in 2018. The transportation sector grew by about 140,000 b/d in 2018 as a result of increased demand for fuels such as petroleum diesel and jet fuel.

Natural gas consumption in the United States reached a record high 83.1 billion cubic feet/day (Bcf/d), the equivalent of 31 quadrillion Btu, in 2018. Natural gas use rose across all sectors in 2018, primarily driven by weather-related factors that increased demand for space heating during the winter and for air conditioning during the summer. As more natural gas-fired power plants came online and existing natural gas-fired power plants were used more often, natural gas consumption in the electric power sector increased 15% from 2017 levels to 29.1 Bcf/d. Natural gas consumption also grew in the residential, commercial, and industrial sectors in 2018, increasing 13%, 10%, and 4% compared with 2017 levels, respectively.

Coal consumption in the United States fell to 688 million short tons (13 quadrillion Btu) in 2018, the fifth consecutive year of decline. Almost all of the reduction came from the electric power sector, which fell 4% from 2017 levels. Coal-fired power plants continued to be displaced by newer, more efficient natural gas and renewable power generation sources. In 2018, 12.9 gigawatts (GW) of coal-fired capacity were retired, while 14.6 GW of net natural gas-fired capacity were added.

U.S. fossil fuel energy consumption by sector

Source: U.S. Energy Information Administration, Monthly Energy Review

Renewable energy consumption in the United States reached a record high 11.5 quadrillion Btu in 2018, rising 3% from 2017, largely driven by the addition of new wind and solar power plants. Wind electricity consumption increased by 8% while solar consumption rose 22%. Biomass consumption, primarily in the form of transportation fuels such as fuel ethanol and biodiesel, accounted for 45% of all renewable consumption in 2018, up 1% from 2017 levels. Increases in wind, solar, and biomass consumption were partially offset by a 3% decrease in hydroelectricity consumption.

U.S. energy consumption of selected fuels

Source: U.S. Energy Information Administration, Monthly Energy Review

Nuclear consumption in the United States increased less than 1% compared with 2017 levels but still set a record for electricity generation in 2018. The number of total operable nuclear generating units decreased to 98 in September 2018 when the Oyster Creek Nuclear Generating Station in New Jersey was retired. Annual average nuclear capacity factors, which reflect the use of power plants, were slightly higher at 92.6% in 2018 compared with 92.2% in 2017.

More information about total energy consumption, production, trade, and emissions is available in EIA’s Monthly Energy Review.

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April, 17 2019
A New Frontier for LNG Pricing and Contracts

How’s this for a first? As the world’s demand for LNG continues to grow, the world’s largest LNG supplier (Shell) has inked an innovative new deal with one of the world’s largest LNG buyers (Tokyo Gas), including a coal pricing formula link for the first time in a large-scale LNG contract. It’s a notable change in an industry that has long depended on pricing gas off crude, but could this be a sign of new things to come?

Both parties have named the deal an ‘innovative solution’, with Tokyo Gas hailing it as a ‘further diversification of price indexation’ and Shell calling it a ‘tailored solutions including flexible contract terms under a variety of pricing indices.’ Beneath the rhetoric, the actual nuts and bolts is slightly more mundane. The pricing formula link to coal indexation will only be used for part of the supply, with the remainder priced off the conventional oil & gas-linked indexation ie. Brent and Henry Hub pricing. This makes sense, since Tokyo Gas will be sourcing LNG from Shell’s global portfolio – which includes upcoming projects in Canada and the US Gulf Coast. Neither party provided the split of volumes under each pricing method, meaning that the coal-linked portion could be small, acting as a hedge.

However, it is likely that the push for this came from Tokyo Gas. As one of the world’s largest LNG buyers, Tokyo Gas has been at the forefront of redefining the strict traditions of LNG contracts. Reading between the lines, this deal most likely does not include any destination restriction clauses, a change that Tokyo Gas has been particularly pushing for. With the trajectory for Brent crude prices uncertain – owing to a difficult-to-predict balance between OPEC+ and US shale – creating a third link in the pricing formula might be a good move. Particularly since in Japan, LNG faces off directly with coal in power generation. With the general retreat from nuclear power in the country, the coal-LNG battle will intensify.

What does this mean for the rest of the industry? Could coal-linked contracts become the norm? The industry has been discussing new innovations in LNG contracts at the recent LNG2019 conference in Shanghai, while the influx of new American LNG players hungry to seal deals has unleashed a new sense of flexibility. But will there be takers?

I am not a pricing expert but the answer is maybe. While Tokyo Gas predominantly uses natural gas as its power generation fuel (hence the name), it is competing with other players using cheaper coal-based generation. So in Japan, LNG and coal are direct competitors. This is also true in South Korea and much of Southeast Asia. In the two rising Asian LNG powerhouses, however, the situation is different. In China – on track to become the world’s largest LNG buyer in the next two decades – LNG is rarely used in power generation, consumed instead by residential heating. In India – where LNG imports are also rising sharply – LNG is primarily aimed at petrochemicals and fertiliser. LNG based power generation in China and India could see a surge, of course, but that will take plenty of infrastructure, and time, to build. It is far more likely that their contracts will be based off existing LNG or natural gas benchmarks, several of which are being developed in Asia alone.

If it takes off  the coal-link LNG formula is likely to remain a Asian-based development. But with the huge volumes demanded by countries in this region, that’s still a very big niche. Enough perhaps for the innovation to slowly gain traction elsewhere, next stop -  Europe?

The Shell-Tokyo Gas Deal:

Contract – April 2020-March 2030 (10 Years)

Volume – 500,000 metric tons per year

Source – Shell global portfolio

Pricing – Formula based on coal and oil & gas-linked indexes

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