Managing Risk in an Evolving Global LNG Market
Within the last 10 years, the LNG market has experienced dramatic changes as a result of additional supply, primarily from Australia and the US, combined with an increase in demand within the Asia market. These market changes have not only altered the nature of how LNG contracts are structured, but also has affected spot pricing and trade margins, resulting in a shift away from the traditional producer and consumer relationships to a more competitive trading market.
Impact to Trading Contracts
Market changes are forcing producers and buyers to reconsider and renegotiate their traditional sales purchase agreements (SPAs). ExxonMobil Corp., for example, recently lowered the pricing of its 20-year LNG deal with India. Other companies have followed suit, signaling an uphill battle for producers as lower spot prices for global oversupply will continue to result in more contract revisions.
Many market participants are now contracting under an LNG master sales and purchase agreement (MSA), specifically intended for use with spot and short term agreements with substantial flexibility for the buyer and seller to customize the agreement to their needs.
Spot Prices are Decreasing, Giving Traders a Chance to Step in
Spot prices have been driven down about 70% with the increase of LNG in the market; and prices are likely to remain depressed as producers in Australia, the US and Qatar are expected to further ramp up supply. These conditions give traders a chance to step in and be the “middle men.” Estimates show that 2017 shipments contracted through trading houses will triple those in 2015, which was about 3-5% of the market at that time.
Competition is Shrinking Trade Margins
As recently as 2013, traders could pocket millions of dollars on a single trade. Today, that number has decreased to about US $750,000.
In response to the evolving market, traders are increasing their market share to gain efficiencies in logistics and operations, which are important due to shrinking margins. However, as presence in the market increases, risk increases.
Managing Risks and Challenges
The evolving LNG market will provide growth opportunities, but also risks and challenges. As long as we continue to see oversupply, the market will be at the advantage of large buyers of LNG. This market evolution may lead more producers to take on additional risks by compelling them to transact more in the spot market rather than depend upon their traditional long-term contracts.
Additionally, LNG prices need to remain competitive with crude oil and coal as oil still dominates transportation and coal is still the biggest fuel source for electricity, especially in Asia. Participants will be looking to hedge their agreements. Just as with any transaction, there is always credit risk; but the key to succeeding lies in a stringent due diligence process when examining opportunities.
At the end of the day, keeping up with this evolving and increasingly sophisticated market will be necessary in order to gain and maintain market share.
Want to learn how Allegro can help you manage risk in the LNG market? Click here.