The return of the long-term LNG SPA

LNG contracting trends

Data from Poten & Partners LNG Contract Intelligence Service shows that 2021 saw a steep rise in both the number of long-term¹ LNG sale and purchase agreements (LNG SPAs) that were entered into and the total LNG volumes contracted for under such LNG SPAs. This trend has continued in 2022, with the total number of long-term LNG SPAs signed in 2022 at the time of writing already exceeding the total number of long-term LNG SPAs signed in the whole of 2021.

Whilst this shows that there was an increase in the number and volume of long-term LNG sales contracted for in 2021 and 2022, this could have simply been due to an increase in LNG contracting activity during those years. It therefore needs to be determined whether this represented an increase to the share of long-term LNG sales of the global LNG market.

Data from the annual reports published by the International Group of LNG Importers (GIIGNL) shows that the long-term LNG SPAs² signed in 2021 represented 64% of the total volume of LNG sales contracted for in 2021. This was an increase from the 47% share that long-term LNG SPAs had in 2020, but was still nowhere near the 93% share that long-term LNG SPAs had in 2019. The GIIGNL data only goes up to 2021, however, so does not show whether this trend has continued through 2022.

Looking specifically at 2022, the data from Poten & Partners LNG Contract Intelligence Service shows that the number of ^mid-term3 LNG SPAs signed in 2022 dropped off significantly from prior years . As of 11 September 2022, only three mid-term LNG SPAs had been signed in 2022, as compared to 20 mid-term LNG SPAs in 2021 and 12 mid-term LNG SPAs in 2020. This therefore represents a significant move away from mid-term LNG sales towards long-term LNG sales.

The data therefore supports the claim that there has been a resurgence in long-term LNG contracting, but what is driving this change?

COVID-19

In order to look at why long-term LNG sales increased in 2021 and 2022, it is first necessary to look at the situation prior to this increase.

Even before the onset of the COVID-19 pandemic, during 2019 and early 2020 the LNG industry was experiencing a period of over-supply and historically low prices. The COVID-19 pandemic greatly accelerated these issues. In 1H20, with governments across the world imposing lockdowns on the public and on businesses, global demand for natural gas dropped by an estimated 4% y/y;⁴ this was the largest fall on record. This demand destruction resulted in a significant decrease in LNG production, as buyers scrambled to cancel or reschedule cargo deliveries, and global LNG exports fell by 17% between January – June 2020.⁴

The resulting over-supply in the LNG market led to huge drops in LNG and natural gas spot prices, with spot prices hitting record lows in April and May 2020. The Japan Korea Marker (JKM), the LNG benchmark price assessment for spot physical cargoes delivered ex-ship into Japan and South Korea, dropped to a record low of US$1.80/million Btu on 28 April 2020. This was down from US$5.26/million Btu at the start of 2020. Spot natural gas sales at the Dutch Title Transfer Facility (TTF) fell to a record low US$1.13/million Btu on 28 May 2020, down from over US$5.00 at the beginning of 2020.

Lockdowns resulted in delays to LNG projects already under construction, with project developers forced to reduce the number of workers on site to the bare minimum. In addition, even once workers could return to site, the knock-on effects of delays throughout the global supply chain further pushed back the expected start-up dates for new LNG export projects.

COVID-19 also delayed the taking of a final investment decision (FID) on a number of proposed LNG export projects. In 2019, six LNG export projects took FID on nearly 71 million tpy of additional LNG production capacity – a record year for the approval of new LNG export projects. A similar number of FIDs was predicted for 2020 but, due to the effects of the pandemic, Sempra’s Energía Costa Azul project in Mexico was the only LNG export project to take FID in 2020.

The drop in LNG contracting activity in 2020, and the pushing back of FID on all of these delayed projects, has contributed to the increase that has been seen in long-term LNG contracting activity in 2021 and 2022. Despite not having taken FID, project sponsors had invested heavily on these projects and, for many of these projects, it was a question of ‘when’ not ‘if’ they would proceed to FID once market conditions improved.

Buyer opposition to long-term contracts

Due to historically low spot LNG prices in 2019 and 2020, and the resulting price differentials against traditional long-term LNG SPA contract price formulas, many LNG buyers had begun to rely heavily on spot LNG purchases for an increasing share of their LNG demand.

Whilst some LNG buyers saw an opportunity to lock-in low-cost LNG supplies during this period, many LNG buyers were reluctant to commit to long-term LNG SPAs, which they viewed as inflexible and expensive (as against then-current spot LNG prices). This can be seen in the decline in the number of long-term LNG SPAs signed in 2019 and 2020, and in the increase in spot cargo sales as a share of the global LNG market over the same period. The statement quoted in the opening paragraph of this article was made against this backdrop of historically low prices and relative over-supply.

Even amongst the long-term LNG SPAs signed in 2019 and 2020, it can be seen that there was a growing tendency towards shorter contract terms. Data from GIIGNL shows that the weighted average duration of the LNG SPAs signed in 2019 and 2020 was far shorter than those signed in 2018.

Historically, long-term LNG SPAs had tended to be for terms of at least 20 years, as stable long-term revenues were required to support the high capital costs involved in developing LNG liquefaction projects. In addition, project lenders would typically require that the term of each LNG SPA covered the full tenor of the project loans plus a ‘tail’ of 10 – 50% of the term. This tendency for shorter duration LNG SPAs can be demonstrated by the Mozambique LNG project, which managed to secure approximately US$15 billion in project financing in July 2020, backed by LNG SPAs for 75% of its total production with terms of just 13 – 15 years.

Written by Rob Butler, Baker Botts.

This article was originally published in the November 2022 issue of LNG Industry. To read the full article, sign in or register for a free trial.

Read the article online at: https://www.lngindustry.com/special-reports/09112022/the-return-of-the-long-term-lng-spa/