Dawn of a global commodity – LNG trading transformed
Thriving in a commoditized LNG market
The reconfiguration of supply and demand in the LNG industry is on course to change the nature of global trading drastically and permanently.
The traditional ways of doing business, based on destination restricted, oil-indexed long-term contracts, are disappearing, making room for enhanced flexibility and interconnectivity, promoting a more liquid, competitive and transparent marketplace.
Suppliers, challenged with high production costs or waiting to come on stream once the surplus erodes and prices recover, may see this as negative. But new opportunities are also up for grabs for those able to respond fast. Accepting that buyers’ willingness to sign long-term deals largely depends on their ability to reduce risk through destination flexibility is a step towards securing new contracts and project FIDs into the 2020s. Continued investment in emerging markets should help producers diversify downstream portfolios and create outlets to absorb growing global supplies. Entering further into the value chain would boost their ability to optimize cargoes and capture spot value, while supporting the development of the LNG derivatives market could help limit future exposure to price volatility.
Legacy buyers in northeast Asia have seen the supply glut coincide with slowing consumption growth and deregulation in their domestic markets, a combination that is forcing them to prioritize profitability and risk management over security of supply in their LNG purchases. Japan, South Korea and Taiwan represent about half of global LNG consumption, an indication of their strong bargaining power in a buyers’ market and the critical role they will continue to play in reshaping the way LNG is traded. Some have already entered the trading space in a bid to boost optimization capabilities, and are building hedging expertise to mitigate risk should the market tighten and prices rise.
In emerging import markets, particularly across South and Southeast Asia, the prospect of plentiful, cheap LNG for years to come is encouraging the development of a new wave of flexible regasification terminals, amid favorable policies that support a growing role for gas in the energy mix. Investment is pouring in as demand from Northeast Asia and the Middle East slows and international investors appear less constrained by conventional standards of creditworthiness. The level of success and participation of these markets in the future LNG sector will ultimately depend on the continuation of strong government policy initiatives to limit coal dependency, accelerate energy pricing reforms and pursue more flexible LNG contracts.
Nowhere have the disadvantages of rigid contracts become more apparent than in India, where downstream price sensitivity increases the risk of term deliveries becoming uncompetitive, or China, where the struggle of state-owned companies to absorb take-or-pay, oil-priced volumes is hindering the country’s efforts to turn third-party access guidelines into law. More supply flexibility, greater infrastructure access and domestic prices that more closely reflect LNG fundamentals would help these Asian majors open immense opportunities for both domestic and international LNG stakeholders.
Traders have become key facilitators of LNG commoditization, having helped increase competition, cargo churn and the interconnected nature of the physical markets, while actively supporting growth in the derivatives space. Trading can only grow from here, fueled by a wave of flexible supplies, shipping liquidity and the emergence of new untapped markets, but its nature is also changing. Competition is growing, as buyers and suppliers are entering the trading space, while enhanced price transparency is eroding trading margins. Increasing flexible supplies from North America , Middle East and Asia-Pacific are reducing regional and seasonal price differentials, leading to fewer arbitrage opportunities. As competition sharpens and margins shrink, diversifying portfolios into new geographies should boost traders’ ability to respond fast to short arbitrage windows, while expanding across the supply chain could ensure continued access to both strategic information and new buyers.
On the financial side, the ability of lenders to adjust to the new market environment will be crucial to ensuring a continuous flow of finance in the new marketplace, and avoid a supply shortage later into the 2020s once the current wave of projects reach completion. Lenders have been used to funding projects supported by rigid oil linked regulated downstream monopolies. With that old world order ebbing, LNG sector finance will largely depend on acceptance of the increasingly pivotal role of spot markets, with improved operational efficiencies supporting LNG economics and stronger pricing benchmarks strengthening the market’s hedging capabilities.
By the early 2020s, LNG industry stakeholders will be facing a very different market from the one we know today, and there are many reasons to be optimistic. A liquid, flexible and transparent spot market will be key to breaking price segmentation, improving fair competition, boosting energy accessibility for new markets, and facilitating the increasingly vital role gas is set to play in the future energy mix of a post-COP 21 world.