Jon Olson, TruMarx Data Partners, USA, and Sam Bulmer, UK, and Tamir Druz, Israel, Capra Energy, outline best practices for LNG tenders.
LNG transactors have increasingly turned to tenders, or reverse auctions, as their ‘go-to’ process for procuring or offering short and medium-term LNG supplies. While LNG producers do routinely issue tenders for available project cargoes, tender activity is more pronounced on the buy side. Table 1 displays some recent examples of successfully concluded tenders issued by LNG customers around the world.
Figure 1. Short-term LNG deliveries and percentage market share (2000 – 2016) (source: GIIGNL).
By clearly defining their specific requirements and decision process, serious LNG buyers can bring multiple potential suppliers into a highly structured and competitive bidding process that will often yield a much better result than the traditional one-to-one bilateral trading process. Furthermore, properly administered LNG tenders can be conducted more efficiently, reducing demands for organisational resources, and ensuring a conclusion within the required timeframe.
Firstly, this article will explore the various transaction methods being utilised in today’s LNG market, and explain why LNG buyers are increasingly relying on tenders as their preferred transaction method. Then, it will highlight emerging best practices to achieve optimal results from the tender process, based on TruMarx’s and Capra Energy’s experience. Finally, the article will highlight systems technology innovations that can help tenderers realise the full potential inherent within this method of transaction.
Common transaction types in today’s LNG market
Direct bilateral trades
According to the International Group of Liquefied Natural Gas Importers (GIIGNL), the percentage of LNG cargoes delivered under short-term (including spot) transactions has grown from approximately 5% in the year 2000 to almost 30% last year (see Figure 1). LNG cargoes are increasingly being made available for short-term trade via a variety of mechanisms, such as the following:
- The diversion of cargoes initially contracted under long-term sale and purchase agreements (SPAs) or term deals.
- Cargoes that are ‘freed up’ for short-term trade upon the exercise of downward quantity tolerance (DQT) rights or other offtake flexibility.1
- Uncommitted LNG project capacity that is reserved for short-term marketing and trading opportunities.
- Involvement of intermediaries (e.g. Vitol, Trafigura, Glencore) with flexible supply portfolios geared toward short and medium-term trading and optimisation.
Until recently, most of this short-term trade was executed via one-to-one, direct bilateral negotiations. An LNG buyer or seller could shop around for offers or bids among a relatively limited pool of suitable potential counterparties. Furthermore, this has generally been a fairly technology-lite process. Transactors communicate via instant messages, emails and phone calls, making it difficult to follow a transaction’s history for purposes of team collaboration, compliance, audits or other critical activities.
Figure 2. LNG tender structuring screens in COMET – structure screen (source: TruMarx Data Partners).
Intermediated (brokered) trades
Some LNG transactors have made use of specialised brokers in the hope of reducing some of the legwork associated with the direct bilateral process. Another motivation among LNG brokerage users might be to try and conceal their identity and physical portfolio needs in the hope of achieving better deal pricing. Maintaining secrecy can be especially challenging in the LNG business, however, since information regarding LNG quality, location and other parameters may readily reveal the identity of a broker’s customer to the more sophisticated market players that they contact.
In addition to the confidentiality hurdle, LNG brokers often struggled to justify their fees in a market where transactors were still able and willing to reach out to counterparties directly. While the direct bilateral process might reduce confidentiality, it does provide greater control over the transaction process, something many transactors might prefer.
In recent years, LNG markets and projects have proliferated at a pace that is just as impressive as that seen for LNG short-term trade growth. For example, while there were only 17 markets importing LNG a decade ago, there are now approximately 40. As the pool of potential transaction counterparties has expanded, the direct bilateral process has become increasingly cumbersome and inefficient for a wide range of LNG trading needs, especially in the absence of enhanced transaction supporting technologies.
This is especially true when transacting multiple cargoes for a multi-month or multi-year period. These transactions will often have pricing, flexibility and other features reminiscent of long-term SPAs, which would be difficult to address efficiently with multiple potential counterparties one at a time through the direct bilateral approach. Furthermore, a suitable counterparty may need to demonstrate financial, operational and other qualifications beyond those required for a single cargo transaction.
Figure 3. LNG tender structuring screens in COMET – shape screen (source: TruMarx Data Partners).
Therefore, for multi-cargo transactions especially, the tender process has emerged as the preferred process for buyers or sellers to efficiently interface with multiple potential counterparties all at once. The tenderer announces the intention to take or make delivery of a series of cargoes at a specific location over a designated time period, and invites interested bidders to submit their best proposal by a specified deadline. The tenderer will then select the most attractive proposal from among the bids that are submitted. While the selection criteria are typically biased heavily toward the best price, other factors, such as credit rankings, may also be considered, even among qualified bidders.
The tender process inherently favours the issuer since it encourages multiple bidders to compete for the same tender award. In effect, the successful bidder must beat the best market price that would have existed without their participation to win the tender. In addition, in most cases, a tenderer will reserve the right not to award the tender to any of the bidders if the price does not meet its expectations.
The degree to which tenderers succeed in reaping the benefits of the tender method depends on how well they manage the process. Best practices for a well-managed tender include a variety of both ‘dos’ and ‘don’ts’. This article will now enumerate many of these. At the same time, this article will highlight opportunities for integrating many of these best practices into an organisation’s tendering process by using a leading trading platform that is expressly designed with these goals in mind – TruMarx’s COMETTM system.
LNG tender process best practices: practical guidance
Clearly define and communicate the tender’s requirements and process up front
Effective tender preparation requires a cross-functional effort involving technical, commercial, legal and other internal and external resources so as to minimise the need for clarifications and amendments after the tender has been issued. This is particularly the case for first-time tenderers, some of whom have been known to issue more pages of clarifications than the original number of pages in the bid document.
Nevertheless, after the initial few tenders, the process tends to become far more streamlined. With prior learnings incorporated, standard tender templates can be developed that merely require tender-specific details to be inserted, i.e. the number of cargoes, delivery windows, etc. As such, experienced tenders are increasingly using the tender methodology for shorter-term cargo opportunities.
COMET facilitates the design and deployment of new LNG tenders by guiding both new and experienced issuers through the drafting process using a structured set of screen templates that fully define both the requirements and flexibilities of the tenderer.
Carefully manage risk exposure
In order to obtain the most competitive price achievable, the tenderer must encourage as many high-quality bidders as possible to compete against each other for the award of the tender. Tenderers must therefore seek to minimise any barriers that would prevent bidders from participating. The next best practice lays out several practical steps that can be taken to boost participation.
However, this goal must be balanced against the need to screen out low-quality bidders that could potentially expose the tenderer to risks. Such risks include the following:
- Credit risk – The risk that the successful bidder might not have the financial resources to pay for deliveries after it has received them from the tenderer (in the case of a sell tender), or that the bidder may cease trading activities due to bankruptcy during the supply period, forcing the tenderer to go back into the market and replace these supplies at a potentially higher price (in the case of a buy tender).
- Performance risk – The risk that the counterparty may not have access to the LNG cargoes that it has committed to deliver to the tenderer, or that it lacks the shipping or other technical expertise to deliver.
- Reputational risk – The risk that the bidder may be involved in questionable business activities which could tarnish the reputation of the tenderer by association.
Encourage tender participation by reducing unnecessary barriers
This article will now lay out various obstacles that the company has seen to tender participation, and will provide practical guidance for avoiding these.
Minimise unnecessary paperwork and outdated protocols
Some tenderers, particularly state-owned entities, place an excessive administrative burden on those who participate in their tender processes. As just one example, some tenderers require that bids be submitted in physical paper form as well as in electronic format. Bid documents can amount to hundreds of pages with each page needing to be initialled by a senior staff member. As a consequence, some bidders who may otherwise meet all of the eligibility criteria, may choose not to submit a bid due to the excessively burdensome administrative requirements.
It is important for tenderers to remember that bid teams within organisations may be preparing several tenders at the same time and may be forced to prioritise their resources to other opportunities. It is recommended that tenderers think carefully about how the tender process can be streamlined and how encrypted electronic communications, digital signatures and other technologies can be utilised. Again, COMET is a good example of a systems solution that can ensure a rigorous process while reducing unnecessary burdens.
Avoid excessive guarantees and bidding fees
Some tenderers will employ the use of bid or performance guarantees to further minimise their risks. Bid guarantees are issued by third-parties (banks) on behalf of the bidders in favour of the tenderer for the duration of the bid validity period. Bid guarantees often carry a value of several million US$ and are designed to deter any bidders from withdrawing after the submission deadline while the tenderer selects a winner.
Similarly, performance guarantees are used by tenderers to cover the risk that the winning bidder will renege on its commitments during the delivery period and that replacement cargoes will need to be sourced in the market.
While these guarantees can serve to protect against legitimate risks, their use should be limited to multi-cargo tenders that deliver over extended periods of months or years, since they do involve both a financial and administrative cost for bidders, and they do not provide as much of a benefit for short-term tenders.
Also, some tenderers require that bidders pay a fee for bid documents that can run into the thousands of US$. If they are used as a means for generating revenue from the tender process, bid fees should be avoided, since they may discourage participation by qualified bidders.
Keep bid validity periods reasonably short
Some tenderers commit to selecting a winner of a tender within a couple of working days. Other tenderers may take weeks to come to a decision on which bidder to award. For the bidders, committing to tenders with long validity periods can be a risky affair. Not only are bidders obliged to hold cargoes in reserve for the duration bid validity period, potentially restricting their ability to participate in other tenders, but bidders may also be subject to significant price risks during this time.
This is because bidders will submit bids at price levels based on prevailing market conditions as of or prior to the bid deadline. The longer the bid validity period, the greater the chance that market conditions may shift significantly while bidders await the award decision. Unfortunately, bidders have limited ability to hedge or otherwise manage this exposure until they have been notified of their award. Many bidders may therefore prioritise tenders with shorter bid validity periods so as to mitigate this risk.
Avoid post-tender price negotiation and other questionable tactics
It is not uncommon for some tenderers to further negotiate after final bids have been submitted in order to squeeze out additional cents. In some cases, these questionable negotiation tactics have involved asking ‘shortlisted’ bidders to improve their bids further in order to be awarded the tender. In others, the ‘winning’ bidder might be advised that they must match the best price from a prior tender to be awarded the tender, even though market conditions may have changed or the tenders are not completely comparable. These attempts may compromise the integrity of the tender process and its purpose, not to mention the tenderer’s market reputation. It is recommended that tenderers be careful to avoid such practices.
Allow pricing formula flexibility when mutually beneficial
Historically, LNG tenderers have been relatively inflexible regarding acceptable pricing indices, often specifying that all bids must be indexed to Brent crude oil to be considered. Nevertheless, there may be several bidders that are naturally exposed to a different index against which they may be able to offer more competitive pricing. These alternative indices may also be equally compatible with the tenderer’s portfolio risk management needs and hedging capabilities.
The COMET platform is designed to enable bids based on any index used within the physical LNG markets (e.g. NBP, JKM, Henry Hub, etc.), as well as Brent, should the tenderer wish to provide this flexibility. Furthermore, the platform is equipped with a bid comparison tool that enables an ‘apples-to-apples’ comparison of competing bids on a US$/million Btu basis given prevailing levels for alternative indices that may have been used by the various bidders. Table 2 compares monthly and overall average prices across five bids employing different indices for an illustrative tender administered using COMET.
Avoid schedule conflicts with competing tenders
To the extent that it is possible, prospective tenderers should try and avoid tender process schedules that overlap with those of other tenders being issued in the market. This is especially the case when other tenderers have issued relatively large, multi-year tenders, and they have similar natural respondents. For many bidders with limited portfolios and internal risk constraints, it may not be possible to submit bids into two simultaneous tenders with overlapping bid validity periods since there is a chance of being inadvertently successful in both. Prospective tenderers would therefore be wise to time their bid validity period soon after the result of another large tender is announced. This way, all the cargoes that have been held ‘in reserve’ by the bidders, will once again become available.
Tenders are assuming an increasingly important role in LNG trading. This trend is expected to continue, as participation and liquidity in the short-term physical LNG market continues to expand, and transactors seek out a more manageable and competitive process than might be possible via direct bilateral or intermediated transactions. In order to fully realise the benefits of LNG tenders, issuers should pursue best practices such as the ones outlined in this article. These should help tenderers to streamline their tender processes and encourage robust bidder participation, while avoiding a number of potential pitfalls. The COMET platform is an important and timely innovation for helping tenderers to achieve these goals, and should therefore be considered as a useful tool for achieving a best practice LNG tender process.
Notes and references
For a more complete definition and discussion of offtake flexibility, see: http://capraenergy.com/capra-energy-journal/lng-market-offering-more-favorable-offtake-provisions-for-buyers
Read the article online at: https://www.lngindustry.com/liquid-natural-gas/10102017/tips-for-better-lng-tenders/