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Risk part of LNG growth Producers expected to share price risk in supplying LNG to U.S. Larry Persily Petroleum News Juneau Correspondent
Producers will likely find themselves sharing the price and volume risks as they move strongly into the growing U.S. market for imported liquefied natural gas, says a report by Cambridge Energy Research Associates.
As the U.S. market for LNG grows, the report says, suppliers will need to “bridge the gap” between North America’s history of volatile gas prices and short-term contracts vs. the stability of longer-term LNG supply contracts traditionally demanded by producers and lenders for other markets.
Attracting the billions of dollars in new investments for upstream supplies, LNG tankers and receiving terminals will require that sellers and buyers find an affordable middle ground between the risks to their respective bottom lines.
“Producers will … have to accept some of the price risks and volatility that are part and parcel of the U.S. market,” said the CERA report, The Incoming Tide: LNG Surges into North America.
Other industry reports see the same shift toward a new financial structure for U.S. markets, with producers and buyers each giving up some security. Long-term contracts not the norm for U.S. Long-term contracts were a fixture of not only the Asian LNG market in past years, but Europe, too, was willing to sign up for guaranteed supply. “Unlike may U.S. power developers, the European developers do not have an adversity to signing long-term firm contracts for supply,” said a 2003 report from Wood Mackenzie, a worldwide oil and gas consulting firm.
Moving away from the rest of the world’s acceptance of long-term contracts — where the buyers take most if not all of the risk — and entering the hazards of the U.S. market will take some getting used to as producers look to sell a growing volume of LNG in the years ahead.
The United States consumed about 4 percent of the world’s LNG deliveries in 2002, with strong demand estimates leading to projections that the U.S. market could exceed 20 percent of worldwide LNG consumption by 2010. U.S. could pass Japan as top LNG importer “Within 10 years, the United States could surpass Japan as the largest LNG importer in the world,” the Cambridge Energy report said.
Feeding that growth will take billions of dollars in investment in upstream and downstream facilities. And, of importance to producing company shareholders, it could mean sharing more of the price risk of new development projects than in the past.
“Producers that wish to sell LNG according to the practices and terms of the old LNG paradigm (of long-term contracts) are not likely to penetrate the U.S. market,” CERA said.
That old paradigm placed a higher value on long-term supply, to the financial benefit of producers. Buyers took more of the risk “Traditional (non-U.S.) LNG contracts focused on security of supply,” said the U.S. Energy Information Administration in a December report on LNG markets. “Take-or-pay clauses shifted the volume risk to the buyer,” providing more protection to the producers.
Changes away from long-term, take-or-pay LNG contracts in the Far East have been under way for several years, and are accelerating as a growing oversupply chases after a demand that isn’t growing nearly as fast. It’s becoming a bit of a buyer’s market.
“Recent changes in the LNG market have trended toward increased flexibility,” the federal report said. “Contracts have loosened terms on both price and volume, and can be negotiated for shorter periods of time.”
It’s always been different in the United States, the report said, where short-term contracts and bouncing gas prices made it difficult if sellers — and their lenders — were looking to lock in a steady revenue stream. Volatile U.S. markets make it harder “Importers and exporters involved in U.S. LNG transactions are exposed to a significant level of risk given the high degree of price volatility in U.S. natural gas markets,” the federal report said.
It’s all about who is going to take how much of the painful risks: that prices might fall, if you are the seller; or that they might rise, if you are the buyer.
“A significant part of the market risk appears to have migrated upstream,” said natural gas consultant Jim Jensen, of Jensen Associates in Weston, Mass. “The real governing force for LNG growth is upstream, where the largest and riskiest investments are concentrated,” Jensen said at an October meeting of petroleum investment analysts.
Bringing global LNG supplies to the United States is a “contracting conundrum,” said CERA.
“A way must be found to bring to bring together a global gas market characterized by long-term, take-or-pay contracts … with a North American market with a bias toward shorter-term deals,” the report said.
“The softening of the LNG paradigm (long-term contracts) and the rise of North America as a market for LNG are mutually reinforcing developments. CERA expects continued movement on both fronts, driven by economic necessity.”
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