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Why LNG doesn’t trade like oil Liquefied natural gas marketed regionally, based on long-term contracts, while crude oil has a global market with transparent prices Jeannette Lee Researcher/Writer, Office of the Federal Coordinator
The multibillion-dollar natural gas project proposed for Alaska looks similar to the oil pipeline built almost 40 years ago: Extract a hydrocarbon from the North Slope and send it through an 800-mile pipeline to a year-round port, then pour it into ships to take the product to market.
But comparing the two commodities is like comparing baseball and slow-pitch softball. Oil and LNG are in many ways related, but their markets are separated by essential differences in how they’re played - especially the curves thrown at traders, and whether buyers or sellers have the home-field pricing advantage.
Oil is a global commodity trading rapidly, frequently and at enormous volumes on spot and futures exchanges among a vast array of producing, consuming, shipping and trading firms that have shaped the business since the first international oil deals more than 150 years ago. Prices are transparent and keyed to widely accepted benchmarks based in large part on the composition of the crude.
By contrast, liquefied natural gas is still largely a regional industry and, at 50 years old, much younger. Oil is the established old-timer, while LNG is the youngster trying to make the big leagues.
Despite its youth, LNG has some established traditions. It remains governed by the sanctity of long-term contracts and relationships between a relatively small number of buyers and sellers. Prices are less transparent than those for oil, though buyers are pushing to change the benchmarks for calculating prices.
The LNG trade is in its second decade of considerable growth, but still trades at a much smaller volume than oil. Much of that has to do with supply. Average daily global oil production is almost 15 times that of LNG on an energy-equivalent basis.
Of the almost 200 countries in the world, fewer than 30 import LNG and just 20 export the fuel, whereas nearly every country trades in oil.
Why is oil a global commodity, while LNG is not? The answer lies in supply, transportation and the number of buyers and sellers in each market.
Oil dominates energy trading A crowd of shouting traders flashing cryptic hand signals in the pit of the New York Mercantile Exchange is perhaps the scene most emblematic of the world oil trade. The NYMEX, the largest physical commodities exchange in the world, is where much of the buying and selling of oil futures (contracts for future deliveries) takes place. Oil contracts are also traded through the Intercontinental Exchange in London and other smaller exchanges, as well as electronically 24 hours a day.
Light Sweet Crude Oil (also known as West Texas Intermediate) futures and options (the option to buy or sell oil at a future date) are the world’s most actively traded energy investments. The 850,000 WTI futures and options contracts traded on an average day represent 850 million barrels, almost 10 times daily global oil consumption.
Futures trading develops in the wake of vibrant markets in which prices are volatile and unpredictable. To minimize the risk of losses caused by price swings, buyers and sellers seek ways to lock in prices for deliveries at future dates. They may bet wrong and overpay or underpay as the market moves, but they will have protected themselves against too much movement - or profited if they bet correctly.
Speculators, who bet on the price swings and often have no intention of actually delivering or taking delivery of any oil, are another set of important actors on exchanges and frequently act as counterparties to buyers and sellers.
There is no equivalent in the LNG world to the frenzy of futures exchanges like the NYMEX. In fact, there is no futures trading at all.
Japan, the world’s largest buyer of LNG, plans to list the world’s first futures contracts for LNG on the Tokyo Commodity Exchange by sometime in 2015, but that will not mean LNG all of a sudden becomes a global commodity. In fact, most analysts do not believe that it will be traded as a global commodity anytime soon, even if futures contracts are sold in Japan. There just isn’t enough of it available and sold openly.
Growing spot markets for LNG Oil is also traded on a spot basis for individual cargoes, with main spot markets or trading centers in Rotterdam for Europe, Singapore for Asia and New York for the United States.
In contrast, most LNG changes hands privately through long-term contracts typically spanning 15 to 20 years. The enormous capital cost of liquefied gas projects is one reason deals are most commonly cemented on a long-term basis between producers and customers. Producers need the certainty that they can sell their product in order to attract financing for pricey investments in liquefaction plants, storage tanks and LNG carriers that cost twice as much as oil tankers. Even a small liquefaction project can top $10 billion, with the larger and more complex projects costing $30 billion and up.
Long-term contracts cover everything from upstream gas-supply agreements to shipping charters to loan arrangements and, of course, the LNG sale and purchase agreement, Nelly Mikhaiel, a New York City-based senior consultant at FACTS Global Energy, wrote in a July 2014 email interview. The destination and any resale under these sales-and-purchase agreements are typically tightly controlled.
Still, spot trading and short-term contracts (considered to be four years or less) make up a growing segment of LNG trading - rising in the past decade from around 5 percent to 20 percent of worldwide trade.
For contracts starting delivery before 2000 the average length for contracts was 20.3 years, while contracts starting delivery after 2000 averaged 16.7 years. The shrinking contract durations are due to declining gas production at mature fields in Australia and Asia; new projects with smaller feed-gas reserves than those in the past; greater desire by producing countries to keep more gas for domestic use; and the rise of the short-term market, Mikhaiel wrote.
LNG enters the spot market for many reasons.
Projects sometimes produce more LNG than expected and sell the excess on the spot market. Or a project might reach a final investment decision without committing 100 percent of its production. Perhaps the developers could not secure long-term buyers for all of the volume (due to differences of opinion about key issues such as pricing). Or, satisfied that enough of the production had been sold under long-term contracts to turn a profit, they might choose to retain a little gas for opportunistic sales.
Buyers can also be a source of spot sales. Under less common but more flexible deals, buyers may be able to sell some of their cargoes on the open market. These deals let buyers rid themselves of excess LNG or play the spot market for better returns.
Supply speaks volumes The cacophony of the NYMEX, described as “a great roaring rug of squall” by journalist Lisa Margonelli in her 2008 book, “Oil on the Brain,” is made possible in part by steady supplies of American crude oil with industry-accepted grading standards.
Ample supplies of a commodity are important for backing up contracts on a futures exchange. Sellers need to be able to guarantee that buyers will get the product, should they choose to take physical delivery.
The plentiful supply of West Texas Intermediate powers the NYMEX engine. Crude streams elsewhere in the world help keep other exchanges busy.
The LNG trade, in contrast, lacks oil’s volume. Global oil production in 2013 was 86 million barrels per day; the export-import trade averaged 56 million barrels a day. The amount of LNG traded was equal to 5.9 million barrels of oil per day.
The problem is not the existence of natural gas itself, which is abundant. Proved reserves of oil in 2013 were almost 1.7 trillion barrels, and the natural gas equivalent was likewise impressive at 1.23 trillion barrels.
LNG costly to transport Oil enjoys a robust global transportation network of pipelines, tankers, trucks and trains. There are thousands of ports dedicated to loading and unloading oil; a large, competitive and flexible shipping fleet to carry oil from buyers to sellers; and hundreds of refineries around the world dedicated to making a wide range of petroleum products.
For LNG, transportation costs and logistics are a major impediment to expanding the market to the point where it could become a globally traded commodity like oil.
Most natural gas moves by pipeline, which works just fine on dry land or short distances underwater. But to cross an ocean, supercooling the gas into a liquid that can be loaded on to a ship is a more cost-effective way to move the molecules.
“The transportation of natural gas ... is a challenge much more difficult to overcome than arguably any other fuel,” The World Energy Council said in its 2010 report, “Logistics Bottlenecks.” The council was referring to both pipeline gas and LNG, but the transportation costs and challenges tend to be even larger for LNG.
Because of the high costs and technological complexities, liquefied gas is preferred to pipeline gas only when geopolitics, physical distances or ocean trenches render pipelines impractical or cost-ineffective.
Out on the high seas, oil wins on volume and cost.
Almost 10 times more oil than LNG moved by sea in 2012, measured in tons per mile, according to the United Nations Conference on Trade and Development.
Oil is immensely more energy-dense and profitable per tanker load than LNG. The payload aboard a 1,000-foot long LNG tanker carrying a spot-sales cargo to Asia in summer 2014 was worth almost $40 million. An oil tanker of the same size would be carrying more than $100 million worth of crude.
Editor’s note: Part 2 of this story will appear in the Oct. 26 issue.
Editor’s note: This is a reprint from the Office of the Federal Coordinator, Alaska Natural Gas Transportation Projects, online at www.arcticgas.gov/why-lng-does-not-trade-like-oil.
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