The global liquefied natural gas (LNG) market is transforming. As trading opens up, commodity traders are positioning themselves by grabbing a growing share of supply. Aleya Begum Lønsetteig reports.
The global liquefied natural gas (LNG) market is undergoing an evolutionary transformation. As supply overhang continues to plague the sector, producers are being pushed to offer more flexibility in a market that has traditionally been rigid and dominated by a small number of big players. This is creating a competitive space into which independent commodity traders are rapidly moving.
“We are witnessing the birth and emergence of a new commodity and a huge market – this is a fascinating moment,” says founder and managing partner at Lambert Commodities, Jean-Francois Lambert.
Towards a more flexible market
Typically, gas, both the dry and super-cooled type, is sold under long-term contracts that lock in producers and consumers and leave little room for intermediaries. But an ongoing supply glut in the market is seeing less enthusiasm from buyers to enter into these long-term commitments, which in the past has seen them lose out as prices have plummeted. Many contracts that were entered into 20 or so years ago, are now coming up for expiry and producers are having a hard time renewing and replacing them.
There are numerous reasons why supply is in abundance. In 2011, the Fukushima nuclear power plant accident in Japan saw many governments around the world decide to switch off nuclear plants, leading to speculation that gas would take its place as an energy source fuel. Gas has also been marketed as the ‘clean’ fossil fuel to partner with intermittent renewable energy, leading producers to ramp up their production in response. Moreover, new supply has come on stream from Australia and the US, where the shale revolution saw it transform from being an importer to an exporter. All this, together with a shift in policy, which saw nuclear plants being switched back on, has seen gas supply go from plentiful to painful.
On the demand side, according to the International Energy Agency (IEA), global gas consumption is expected to grow by 1.6% a year for the next five years, with consumption reaching almost 4,000 billion cubic metres (bcm) by 2022, up from 3,630 bcm in 2016. However, despite the upwards trend, demand has failed to keep up with supply, resulting in gas prices dipping to new lows.
Meanwhile, LNG’s share of gas consumption is on the up. The International Group of LNG Importers (GIIGLN) reports that the share of spot and short-term transactions (contracts of four years or less) accounted for 28% of all traded gas in 2016. Primarily driven by Australian volumes and by growing demand in China and India, intra-Pacific LNG trade held the lion’s share (43%) of global LNG flows in the year. According to oil and gas producer Shell, the LNG sector has grown by an average of 6% per year since 2000 and is set to grow at 4-5% annually between 2015 and 2030. By 2020, the producer forecasts the size of global LNG trade to grow by 50% compared to volumes in 2014.
A major driver of LNG growth has been the increased use of floating storage and regasification units (FSRUs). The floating barges have not only meant an opening up of new geographical markets for exporting due to the mobility factor, but they also require significantly reduced upfront capital costs, thereby attracting new countries to the market.
The FSRU business started 2001 and today there are 26 FSRU vessels in operation, with a further 10 in construction, according to the Oxford Energy Institute (OEI). A recent International Gas Union report estimated that close to 50 FSRUs could be in operation by 2025 with the capacity to import close to 200 tonnes per annum (MTPA), which equates to about 60% of the world’s LNG production in 2016.
According to the OEI, the capital cost of an FSRU can typically be 40-50% less than an equivalent onshore terminal, with the lower capital outlay and the improved cash flow significantly improving the project economics. Moreover, most FSRUs are leased as the vessel is owned by a shipping company and can be reassigned on project completion. This is a major advantage over onshore terminals which require large plots of land and where the construction cost must be regarded as a sunk cost. Whereas as a flexible asset an FSRU can be relocated to meet seasonal demand. For example, the LNG terminal in Kuwait is used to supply the country during the peak period from March to November, when gas demand for air conditioning is high. During the winter months the vessel operates as an LNG export tanker, maximising asset utilisation.
FSRUs have also become larger, with more capacity. While earlier models typically had 130,000m3 tankers that sent out rates of 2-3 MTPA, the more recent vessels have 173,000m3 tankers and can carry up to 6 MTPA – offering the same processing capability as land-based terminals.
All this has opened up new opportunities and led to new players entering the market. According to the IEA, the number of countries importing LNG has grown from 15 in 2005 to 39 today, with another eight countries expected to join the list by 2022.
“At the beginning, there were only three big players – South Korea, Taiwan and Japan,” global head of energy at Société Générale CIB, Olivier Musset, tells GTR. “Now many countries are equipped with import terminals which provide them with security of supply. It’s also a great opportunity for traders to act as ‘aggregators’ – being able to manage a portfolio of contracts quantity on a short-term basis. This is all mainly due to FSRUs.”
In order to respond to these changing market dynamics, LNG contracting strategies have had to adapt. Buyers are increasingly demanding more flexibility, not only in pricing competitiveness and off-take obligations, but also in terms of destination.
Japan’s Fair Trade Commission (FTC) ruled in late June that new long-term LNG contracts signed with Japanese buyers could not have destination restrictions – clauses that mandate where a cargo can be delivered and limit buyers from reselling excess gas. The ruling is not only likely to be applied to new contracts going forward but also to those already in existence. It is believed that Japan’s Jera, a joint venture between utilities Chubu Electric and Tokyo Electric, the world’s largest LNG buyer, is likely to push Qatar, the biggest LNG exporter, to renegotiate existing contracts on more favourable terms.
Traders move in
The evolution of the LNG market is also opening up new opportunities for commodity traders.
“The consequence of this is clear. Trading has become a strategic requirement of the market to absorb the excess LNG,” says Lambert. “Suddenly the trading houses, which were totally off this market, are fitting in. The Vitols, Trafiguras, Glencores and Gunvors of this world are saying: ‘We now have a role to play. We can really absorb and play with these short-term or spot contracts in a way we were not able to do or were even considering three or four years ago. I think it’s a fascinating moment because there will not be any return.”
In 2017 Trafigura expects to trade between 7.5 million and 8 million tonnes of LNG, up from 1 million tonnes when it first started in 2013.
“Our volume has grown eight-fold,” Trafigura LNG head Hadi Hallouche tells GTR. “During this period, the market itself has grown in liquidity and in number of players. A lot of companies are now trading LNG. Every single utility in Europe is starting an LNG desk, national companies and even private equity funds have started trading LNG. The multiplication of all of these players also creates a lot of liquidity. Our growth comes within this context.”
In a further step to anchor traders’ roles, in April, Trafigura launched a standard master sales and purchase agreement (MSPA) in LNG trade, something already well established in other commodities. The MSPA aims to provide standard terms and conditions and thereby offering more transparency and better conditions for new entrants – all of which work towards boosting liquidity in the sector.
Also working towards increasing liquidity are the growing number of price indexes and derivatives markets more in tune with LNG. Traditionally, derivatives markets for gas have been linked to crude oil.
“Within the regulatory constraints that are imposed on us, we do our best to participate in every derivative product that is launched,” says Hallouche. “There are a lot of initiatives to launch derivative products in China, Japan, Singapore and the US. We systematically make it a point to always participate in the market.”
In terms of financing LNG, the game is also changing. As the market evolves and new buyers and sellers enter the market, banks are seeing a shift in their lending.
“If you look at the trade finance around trading, LNG works slightly differently because of the value that bills of lading have. We need to help educate the banks so that they understand how the trade works,” says head of structured and trade finance at Trafigura, Stephan Jansma.
“When the desk was building up the trading book our finance teams were building up the knowledge of our banking partners, and now we have more than a sufficient number of banks supporting us. Interest has definitely increased because LNG has a more environmentally friendly connotation to it and we’re pleased that our banking partners are keen to learn and support us in this business.”
At Société Générale, Musset agrees that LNG trade has piqued the interest of bankers.
“We are starting to see more banks entering the LNG territory and interested in financing LNG trade. A few years ago it was the world of big boys like Total, BP, Shell and Chevron – these companies don’t have a need for commodity trade finance,” he says.
Traders up the game
As evidence of their greater foray into the market, the last couple of years has seen numerous wins for trading houses in securing both sales deals and supply of LNG.
On the sales’ side, demonstrating their greater risk appetites, a number of notable wins have been in emerging markets. In June 2017, Swiss trader AOT Energy signed a memorandum of understanding with Bangladesh to help it line up LNG supplies, while earlier in the year Gunvor won a major tender to supply Pakistan with 60 LNG cargoes over a five-year period.
In Egypt, the trading houses have been doing particularly well. In December 2016, Glencore won the biggest share of LNG supplies for the country, equating to around 25 of 60 cargoes, with Trafigura providing 18 cargoes. In 2015, European commodity traders were awarded the lion’s share of tenders to supply Egypt with US$2.2bn-worth of LNG over 2015-16.
But their involvement hasn’t been limited to the emerging markets only. In January 2015, Vitol sealed a deal to provide LNG deliveries to South Korea’s KOMIPO, under a 10-year supply deal for 400,000 tonnes of LNG annually.
On the supply side, Vitol signed a multi-year offtake deal for shipments from Angola LNG in 2017, while Gunvor bagged a 10-year contract for the entire 2.2 million tonnes a year production from Africa’s first proposed deepwater floating LNG export project in Equatorial Guinea. Meanwhile, Vitol has agreed to buy 300,000 tonnes of LNG a year from Russia’s Gazprom from 2018, while Gunvor’s time-swap deal with India’s Gail Energy means the trader gains access to US-produced LNG.
As well as gaining ground with sales and supply deals, trading houses have also moved to integrate themselves along the supply chain. They have done so by joining forces with national energy companies, such as Gunvor with Trinidad’s National Gas Company, Trafigura with Russia’s Rosneft, Vitol with Oman Trading International.
Traders have also been increasing their own investment into LNG infrastructure.
In September, Trafigura, which owns a small share in Pakistan’s second floating import terminal, Pakistan GasPort, announced plans to develop another facility alongside it, including a jetty and berth. In the same month, Bangladesh shortlisted Trafigura and Gunvor to provide two floating LNG import terminals in 2018, in a bid to increase its gas consumption.
Earlier in the year, Trafigura renewed its lease on LNG storage capacity at India’s Kochi import terminal and outlined plans to reopen a defunct LNG import terminal on Teesside in northeast England. Gunvor has also announced that it is part of a consortium, together with Fatima Fertiliser, Shell and Engro, which will install a third terminal in Pakistan, due to come online in late 2018.
“We have been very active in participating in storage,” says Hallouche. “Increasingly we view ourselves not only as a trader but as a logistics company. The opportunity we are seeing is that infrastructure costs are reducing and we believe there is a lot of supply coming onstream, so investing in midstream infrastructure is not only beneficial for us but also to resolve an important constraint in the market. By that I mean ships, FSRUs and ports and regasification terminals.”
Some market commentators foresee traders moving even further into the value chain, and speculate that they may eventually buy or hire FSRUs – and even move into production in some emerging markets.
“I wouldn’t be surprised to see LNG desks in trading houses getting bigger, more sophisticated and start to think about integrating a more comprehensive proposition around energy,” says Lambert.
Whether traders venture that far remains to be seen. But it seems to be the consensus that short-term trading of LNG is here for the long haul.
“I think the market is here for the long-term,” says Musset. “I’m not saying that long-term contract off-take will disappear. There is a need for long-term contracts as some countries wish to have certainty of delivery and certainty of supply with their countries at the mercy of short term LNG. But short-term trading is here to stay.”