Flexible LNG Contracts Prompt Transformation of Finance Models

Flexible U.S. LNG contracts are helping to create a global, commoditized spot market and are transforming project financing models, writes S&P Global Platts, citing the American Petroleum Institute (API). The U.S. could become the world’s third-largest LNG exporter by the end of this year, after Qatar and Australia, and is bringing “unprecedented” options for pricing and contract terms to the market, API policy officer Dustin Meyer tells the market intelligence provider.

“The beauty of U.S. LNG is that no one really knows how it will be priced, and that’s a unique amount of flexibility, of optionality, for potential buyers,” Meyer says. For decades, LNG buyers “really only had one option” for pricing—linking to Brent crude oil. The first wave of U.S. LNG export projects, which are coming online now, generally used prices linked to the U.S. Henry Hub, the pricing point for natural gas futures contracts traded on NYMEX.

But developers for the second wave, who are looking to sign contracts now, are being more flexible to attract buyers. There are many options, including hybrid approaches where prices are linked partly to Henry Hub and partly to a European hub price, such as the Dutch TTF or the UK’s NBP. “Maybe you can mix a bit of Brent oil. Maybe you go all Brent oil,” Meyer comments.

Some developers have even offered a bit of link- age to the West Texas hubs where prices can be extremely low or even negative because there are no links to the coast, yet enable surplus gas to be exported. “It’s really an unprecedented amount of innovation that ultimately benefits the buyer,” Meyer observes, adding that he sees a trend toward more price transparency in the U.S., as well as in Asia and Europe. “That makes project development a lost easier. It’s a sign of the maturing nature of the LNG market as it moves closer to commoditization. The more you get to a spot-based market, the more comfortable financial backers are taking a risk on new export projects, which makes it more likely additional capacity comes online.”

New projects still benefit greatly from having long-term contracts to get them to a final investment decision, however. “If you’re a new company and you’re
only focused on one LNG project in the U.S., then it’s going to be more difficult to get financing unless you have those bankable long-term contracts,” Meyer says. “So you’re still going to see long-term contracts being signed, but they could be for 12 or 15 years, as well as for 20.”

Noted is that long-term contracts do not restrict the rise in spot sales, though, as the cargos can still be sold on a flexible, spot basis by the original buyer. “That’s what we see happening, because there are no destination clauses attached to U.S. LNG,” Meyer explains. Trading houses Trafigura and Gunvor, for example, have been able to enter the market because the increase in flexible U.S. LNG cargos makes it easier to trade in the spot market. “There’s absolutely no obligation for what you do when you pick up your U.S. LNG cargo, and that’s different from how LNG projects used to be developed.”

A growing LNG spot market with more transparent prices also benefits new customers who might not have the credit to sign a long-term contract or build a dedicated import terminal. It helps lower barriers to entry and gives people the freedom to respond to market conditions and add LNG to their portfolios. Meyer is circumspect about European Commission hopes that the U.S. could eventually become the major supplier to Europe—prices, not politicians, drive flows. “There’s no direct way that the EU or national governments can cooperate with the U.S. government in a commercial way to require a certain percentage of volumes of U.S. LNG to go to Europe.”

U.S. LNG exports to Europe have surged in recent quarters as a narrow price spread with Asian LNG made Europe often a more profitable destination. By early May this year, Europe had imported 4.4 billion cu meters (Bcm) of LNG from the U.S., already more than the 4.3 Bcm it imported in the whole of 2018, according to data from S&P Global Platts Analytics. “Governments can be lauded for not creating any obstacles to that, but flows must be left to commercial decisions based on market conditions,” Meyer outlines.

Europe’s U.S. LNG imports are also still tiny compared with its major supplier, Russia, which sent 200 Bcm of pipeline gas and 10 Bcm of LNG to Europe in 2018. By early May, Europe had imported 6.6 Bcm of Russian LNG, more than from the U.S., as well as 37 Bcm of pipeline gas, Platts Analytics data show.

(SOURCE: The Weekly Propane Newsletter, June 3, 2019)