A tremor ran through the world of LNG this week, as news filtered out that India had successfully negotiated a price cut in its 20-year LNG deal with ExxonMobil. This is the second such win for India, which has vocally expressed its grievances of being locked into expensive long-term contracts signed when LNG prices were at their peak, but are now out-of-sync in an increasingly oversupplied market. Most see this as a harbinger of times to come, as LNG buyers gain in power, and many are watching to see if the traditional LNG consuming juggernauts of Japan, South Korea and China might follow.
There are two sides to this story.
From India’s perspective, it marks the second time the country had successfully renegotiated the pricing terms of its LNG contracts. The first was in 2015 with Qatar, and the second with ExxonMobil. Thus far, this is the only such incidence of a major contract revision. Of the major Asian LNG buyers, India has probably been the most aggressive in seeking better deals for LNG prices, though Japan and South Korea have long grumbled as well. Details of the deal are scarce, but reports suggest that LNG will now be supplied at less than 14% of the Brent oil price, from a previous 14.5%, with additional supplies at 12.5%. Under the new deal, ExxonMobil would probably receive some 15% less revenue per unit of sales. Even more surprising is that ExxonMobil agreed to absorb shipping charges, traditionally borne by the buyer. This win could embolden other buyers, pushing for more flexibility and similar concessions from producers.
From ExxonMobil’s perspective, this is the lesser of two evils. Given the amount of LNG sloshing around, there was a chance that India – through Petronet LNG – would walk away from the deal completely. While ExxonMobil would be free to pursue legal damages, it instead chose to win a little concession back. Under the new deal, Petronet LNG will pay less, but will also take an extra million tons from ExxonMobil’s share of the Gorgon project in Australia, raising the total amount to 2.5 mtpa. In an oversaturated market, quantity wins. Better to have a ready outlet for volumes, rather than duke it out in other contracts, possibly for even lower prices. ExxonMobil may have lost some revenue, but it has also guaranteed additional sales of 20 million tons to Petronet over 20 years. With so much more supply yet to come from Australia, Canada, Qatar, the US and Africa, to name a few, from this perspective, this is a win for ExxonMobil.
What does this mean for LNG? These changes were always going to come, due to the tipping of power towards buyers. The market is already moving towards spot and shorter-term contracts in the range of 3-5 years, rather than 15-20 years. Chances are most of the legacy multi-decade contracts will be phased out soon, with new ones signed at terms favourable to buyers. Some buyers will follow India’s lead and demand renegotiation; producers should bend at the knee because a volume sold is better than a volume in storage. They should also take the long-term view.
Yes, LNG supply is rising fast, but fewer new projects are currently being sanctioned. At the rate LNG demand is growing, it looks likely that the market will tighten around 2023-2025. If that happens, the negotiating power will be back with the producers. The trend to shorter-term contracts will actually benefit them then, as price trends will be more favourable. It might cause some pain immediately, but producers should not resist these changes. Flexibility is good for all. And one day, the market will be back in their favour.
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Supply chains are currently in crisis. They have been for a long time now, ever since the start of the Covid-19 pandemic reshaped the way the world works. Stressed shipping networks and operational blockages – coupled with China’s insistence on a Covid-zero policy – means that cargo tanker rates are at an all-time high and that there just aren’t enough of them. McDonalds and KFCs in Asia are running out of French fries to sell, not because there aren’t enough potatoes in Idaho, but because there aren’t enough ships to deliver them to Japan or to Singapore from Los Angeles. The war in Ukraine has placed a particular emphasis on food supply chains by disrupting global wheat and sunflower oil supply chains and kicking off distressingly high levels of food price inflation across North Africa, the Middle East and Asia. It was against this backdrop that Indonesia announced a complete ban on palm oil exports. That nuclear option shocked the markets, set off a potential new supply chain crisis and has particular implications on future of crude oil pricing and biofuels in Asia.
A brief recap. Like most of Asia, Indonesia has been grappling with food price inflation as consequence of Covid-19. Like most of Asia, Indonesia has been attempting to control this through a combination of shielding its most vulnerable citizens through continued subsidies while attempting to optimise supply chains. Like most of Asia, Indonesia hasn’t been to control the market at all, because uncoordinated attempts across a wide spectrum of countries to achieve a similar level of individual protectionism is self-defeating.
Cooking oil is a major product of sensitive importance in Indonesia, and one that it is self-sufficient in as a result of its status as the world’s largest palm oil producer. So large is Indonesia in that regard that its excess palm oil production has been directed to increasingly higher biodiesel mandates, with a B40 mandate – diesel containing 40% of palm material – originally schedule for full implementation this year. But as palm oil prices started rising to all-time highs at the beginning of January, cooking oil started becoming scarcer in Indonesia. The government blamed hoarding and – wary of the Ramadan period and domestic unrest – implemented a Domestic Market Obligation on palm oil refineries, directing them to devote 20% of projected exports for domestic use. Increasingly stricter terms for the DMO continued over February and March, only for an abrupt U-turn in mid-March that removed the DMO completely. But as the war in Ukraine drove prices even further, Indonesia shocked the market by announcing an total ban on palm oil exports in late April. Chaotically, the ban was first clarified to be palm olein only (straight refining cooking oil), but then flip-flopped into a total ban of crude palm oil as well. Markets went haywire, prices jumped to historical highs and Indonesia’s trading partners reacted with alarm.
Joko Widodo has said that the ban will be indefinite until domestic cooking oil prices ‘moderate’. With the global situation as it is, ‘moderate’ is unlikely to be achieved until the end of 2022 at least, if ‘moderate’ is taken to be the previous level of palm oil prices – roughly half of current pricing. Logistically, Indonesia cannot hold out on the ban for more than two months. Only a third of Indonesia’s monthly palm oil production is consumed domestically; the rest is exported. An indefinite ban means that not only fill storage tanks up beyond capacity and estates forced to let fruit rot, but Indonesia will be missing out on crucial revenue from its crude palm oil export tax. Which is used to fund its biodiesel subsidies.
And that’s where the implications on oil come in. Indonesia’s ham-fisted attempt at protectionism has dire implications on biofuels policies in Asia. Palm oil prices within Indonesia might sink as long as surplus volumes can’t make it beyond the borders, but international palm oil prices will remain high as consuming countries pivot to producers like Malaysia, Thailand, Papua New Guinea, West Africa and Latin America. That in turn, threatens the biodiesel mandates in Thailand and Malaysia. The Thai government has already expressed concern over palm-led food price inflation and associated pressure on its (subsidised) biodiesel programme, launching efforts to mitigate the worst effects. Malaysia – which has a more direct approach to subsidised fuels – is also feeling the pinch. Thailand’s move to B10 and Malaysia’s move to B20 is now in jeopardy; in fact, Thailand has regressed its national mandate from B7 to B5. And the reason is that the differential between the bio- and the diesel portion of the biodiesel is now so disparate that subsidy regimes break down. It would be far cheaper – for the government, the tax-payers and consumers – to use straight diesel instead of biodiesel, as evidenced by Thailand’s reversal in mandates.
That, in turn, has implications on crude pricing. While OPEC+ is stubbornly sticking to its gentle approach to managing global crude supply, the stunning rebound in Asian demand has already kept the consumption side tight to match that supply. Crude prices above US$100/b are a recipe for demand destruction, and Asian economies have been preparing for this by looking at alternatives; biofuels for example. In the past four years, Indonesia has converted some of its oil refineries into biodiesel plants; in China, stricter crude import quotas are paving the way for China to clamp down on its status of a fuels exporter in favour of self-sustainability. But what happens when crude prices are high, but the prices of alternatives are higher? That is the case for palm oil now, where the gasoil-palm spread is now triple the previous average.
Part of this situation is due to market dynamics. Part of it is due to geopolitical effects. But part of it is also due to Indonesia’s knee-jerk reaction. Supply disruption at the level of a blanket ban is always seismic and kicks off a chain of unintended consequences; see the OPEC oil shocks of the 70s. Indonesia’s palm oil export ban is almost at that level. ‘Indefinite’ is a vague term and offers no consolation to markets looking for direction. Damage will be done, even if the ban lasts a month. But the longer it lasts – Indonesian general elections are due in February 2024 – the more serious the consequences could be. And the more the oil and refining industry in Asia will have to think about their preconceived notions of the future of oil in the region.
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