CWC LNG and Gas Leaders’ Forum Written by Pat Roberts

This year has got off to a good start in the global LNG industry. LNG demand and prices remain strong in Asia. LNG continues to be diverted from the Atlantic to Asia and a sharp increase in new shipping capacity throughout 2013 - 2014 will allow LNG to move over greater distances. It’s a good business environment currently for short-term sellers and portfolio players. Buyers are having a more difficult time, although new LNG supply projects should be starting up soon in Angola and Algeria and should add to the divertible LNG pool to provide more options for buyers.

Construction activity is moving to a peak level in Australia to progress seven contemporaneous, new supply projects. Furthermore, a staggering 480 million tpa of new LNG capacity is estimated to be at various stages of development all around the world. None of this has, as yet, taken a final investment decision, but each project states it is targeting a pre-2020 start up. This new activity is in response to project developers’ beliefs that the demand for LNG is burgeoning in all demand sectors (including

LNG as a new transportation fuel) and that the long-term health of the LNG industry looks very positive. Finance institutions seem to concur and funds are available for project financing.

But how complacent should we be that tomorrow’s world will evolve much in the way it has in the past?

Are there already signs that big challenges and changes lay ahead as the industry grows in size and complexity?

Are the business models that currently underpin the LNG industry fit for purpose to operate in the LNG world of 2020?

Recent history tells us the LNG industry changes relatively quickly, responding to changes in geopolitics, technical innovations and commercial innovations. For an industry that has roughly doubled every 10 years, standing still is not an option for players, unless they want to see their competitiveness erode.

Frankly, the path to the future is not as obvious, nor straightforward as some of the supply demand forecast charts would lead you to believe. This is because much of the new LNG demand growth is in price sensitive markets, whilst much of the new LNG supply growth is being developed in regions where LNG cost stacks are not (historically) well controlled. Even in mature markets like Japan, there is a wide level of uncertainty over the levels of LNG demand growth as a result of an uncertain nuclear policy and energy efficiency programmes.

Several new LNG ships are entering service in the next couple of years without any employment and several projects under construction are actually running late and over budget. All this adds up to uneven growth in supply chain infrastructure and a much more challenging business environment in which to operate.

Also, there are uncertainties surrounding the role unconventional gas may play in the future. Is it a friend or a competitor of the global LNG industry? It is a friend if it adds to valuable LNG supply growth, but clearly if it displaces LNG demand (by supplying markets with new pipeline gas), then it will depress LNG demand. The extent to which this could happen and the timing is uncertain. Most forecasters think it won’t happen on any large scale until after 2020, yet what would happen if it actually developed faster than this?

In all the cases cited above, flexible LNG business models are needed to respond to sudden changes in changing demand patterns, consequent LNG pricing and trade flows.

April 2013

Flexibility has been the key to several players’ business models in the last 10 years – every player wants it and wants to control it and quite rightly, since volume flexibility and destination flexibility have been significant value drivers whilst arbitrage opportunities prevail.

Looking ahead, flexibility is set to remain core to everyone’s aspired business model. If you have flexibility you can adapt and change to whatever happens in the world. Producers and sellers recognise this, global aggregators built their business models around flexibility – but now it is the buyers who want flexibility as a core component of their business models – to manage volume risk and also to provide additional value whenever arbitrage opportunities arise.

How are business models going to change to reconcile the issue that everyone wants flexibility? Sellers have traditionally said flexibility can be bought at a price. However the industry has been slow to adopt a standard approach for valuing flexibility. As a result, flexibility depends on what you can negotiate.

However, recently there have been some changes evident in the market. Mostly around new LNG supply projects, which are actively under development and looking to take FID as quickly as possible. Here are two examples:

1. Several sellers’ cost stacks cannot accommodate outright price reductions for LNG sales, but they can offer a different business model to their buyers. Some project developers are constructively offering equity farm-ins to buyers into the upstream. There are currently at least seven new projects where buyers have invested in the upstream – several more are likely to follow. Along with equity share comes an entitlement for buyers to have FOB destination free loadings.
2. From some of the prospective North American LNG projects we see a new tolling business model whereby buyers are responsible for constructing their own LNG supply chain, paying a firm long-term tolling liquefaction fee and earning the right to FOB destination free LNG. This new model comes with a whole new set of price risks to manage, but does address some of the flexibility buyers have been seeking.

The business models that underpin the 240 million tpa of LNG in production today, have been evolving continuously, so that today we have a variety coexisting and offering different risk and value sharing for the stakeholders. They range from inflexible seller-buyer point to point models, to very flexible equity tolling models. There are several variations around a particular type, but progressively we see the models changing to reflect new ways of sharing risks and opportunities amongst the stakeholders.

The older style point to point models were characterised by sellers taking price risk and buyer taking volume risk through take or pay contracts. With increasing shipping and regas capacity and LNG sales anchored to liquid markets, which could be diverted, new value has been found through cargo diversions. This has unleashed new value and the opportunity for portfolio optimisation by the party who controls the ultimate destination.

Integrated business models and tolling models have both created more opportunities for portfolio optimisation. Looking to the future, we see various buyers and portfolio players prepared to take price risk (e.g. Henry Hub) to gain FOB destination free LNG. Others are prepared to take upstream risk to earn value across the supply chain and earn an entitlement to FOB LNG to market themselves.

There is no obvious solution of which model will dominate the business in the future. Business models will evolve with the business environment and the appetite for risk between the parties. What is obvious though is that each player needs to understand and actively manage the risks and the value drivers in the model they adopt for their business.

The bottom line

Make sure the business model you adopt will be fit for purpose for your business 20 years forward. Don’t plan solely around what you know and see today. Keep the model flexible and with as many built-in options as possible. The options are valuable and are probably the best means of managing risks in a changing world.

LNG business models will be a topic under active discussion at CWC’s World LNG Series: Asia Pacific Summit in Singapore (24-26 September 2013) and World LNG Summit in Paris (18-21 November 2013).

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