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LNG and the El Niño effect

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LNG Industry,

Wildfire in Indonesia. Floods in East Africa. Active hurricanes in the eastern Pacific. A subdued monsoon season in India. All of these events, and more, are being attributed to the 2015/2016 edition of El Niño, likely to be one of the three strongest ever recorded.

When El Niño produces such extreme and varied affects worldwide, it inevitably grabs the headlines. But for industries with global supply chains, tight margins, complex logistics and a heavy reliance on international shipping, El Niño is just one extreme example of the day-to-day challenges that the weather presents.

This is certainly true of the worldwide LNG industry, whose global trade passed 241 million t in 2014 (an increase of 4.3 million t over 2013 levels). New LNG frontiers have emerged in the US Gulf Coast and Canada, the deepwater basins of East Africa, and in the brownfield projects of Asia Pacific, among others. In this growing, dynamic and interconnected value chain, the weather is a key external factor, affecting output and squeezing margins.

Even a small storm or particularly thick fog can have a debilitating effect on profits and partnerships. Adverse weather conditions can strongly affect trading routes and common shipping lanes. Journeys that are hastened or slowed by intense winds, high waves or restricted visibility can cause bottlenecks at ports, leading to extra costs in demurrage and penalties for unscheduled delivery. Further effects can be felt in broken lending and borrowing arrangements, shortage or excess of supply, breached contracts, unplanned boil off, and inefficient operation of vessels and use of bunker fuel.

And because LNG operations are akin to a finely tuned machine, any disruption to one part of the operation will have a knock-on effect somewhere else – often exaggerating the problem still further.

Shipping routes under pressure

What makes this year’s El Niño even more interesting for the global LNG industry is that it coincides with the certification of the Panama Canal for LNG carriers, and the rapid development of LNG facilities as the US boom in shale takes hold.

LNG has now joined the extensive list of commodities that traverse one of the world’s busiest shipping routes, cutting journey times between Pacific and Atlantic significantly, and creating a much safer option than traditional courses around Cape Horn. Its role in creating a competitive market for US operators is not to be underestimated.

But the opening up of the Panama Canal itself demonstrates exactly why weather can pose such a challenge to optimal LNG operations. The risks associated with having a ship carrying highly flammable gas stored under pressure pass through the canal means there are strictly enforced rules relating to the order, spacing and timing of traffic, in both directions. Operators themselves have to ensure they have the right type of vessel – the canal’s dimensions and depth place limits on tonnage – which affects fleet composition. Insurance also has to be adjusted to take these new risks into account.

For example, a ship delayed by unexpectedly heavy fog in the Gulf of Mexico misses its scheduled slot to transit the Canal. Instead it finds itself holed up for days before another appropriate time can be found – thereby missing its scheduled delivery and loading times at its eventual destination in the northeast of Asia, with all the operational costs and loss of business that entails. The Panama Canal, for all the advantages it opens up, also emphasises the need to understand and account for weather variability. 

Seasonal variations and extreme events

Naturally, LNG operators make allowances for the natural uncertainty of seasonal variations: winter demand and typical winter weather can be ‘baked in’ to delivery schedules. Even the arrival of an El Niño itself is fairly predictable: it takes place every two to seven years and is indicated by warming of Pacific waters. Vessel operators know to make adjustments to trans-Pacific journeys as a result.

What is much harder to forecast is the duration and intensity of the event, and the effect it will have on normal seasonal variations. As little as 18 months ago, there was some doubt among meteorologists about how severe this most recent El Niño would be. Like any other weather conditions, predicting the outcome of an El Niño is very much a question of probabilities rather than certainties.

This is where advanced modelling and simulation comes into play. The sheer number of variables created by even normal weather conditions is huge: far too large for anything but the most advanced computational techniques to make sense of. What simulation can do is make clear the most likely outcomes in any number of given scenarios, enabling evidence-based decision-making and giving LNG operators the confidence of knowing what the outcome of their journey scheduling is most likely to be.

By using advanced modelling techniques – and visualisations to give clarity to the results – operators can plan routes more effectively, choose the size and capacity of ships, schedule berthing and docking more efficiently – and ensure that supply matches demand.

Protecting investments and supporting consortia

However, the value of simulation can be seen far earlier in the LNG value chain. El Niño year or not, the weather will always be a major external factor on commodity businesses in general and LNG in particular. Understanding its impact before investing in major infrastructure and equipment is critical, particularly as the industry grows and becomes more competitive.

This is exactly what is happening in the US, where new LNG players are looking at their plans for liquefaction and storage facilities on the Gulf coast. The decision on how much equipment is needed is not just a factor of how much gas is available: it is also a factor of how much gas can be transported out of the site, the navigability of the local waterways, and the location of potential customers.

The weather affects all of these. Consider again that fog in the Gulf of Mexico – not only does it affect journeys from existing operations, it is also a consideration for any organisation attempting to work out planning liquefaction, storage, or transport facilities in Texas and Southern Louisiana. 

For example, a producer may decide to commit to shipping more than 12 million tpy based on theoretical transport capacity and estimated demand. It invests in the necessary liquefaction and storage infrastructure and enters into consortiums with various shipping partners to ensure that 12 million t are distributed each year.

But if it turns out that it can only deliver 11.5 million tpy, then it has invested too much and is over-paying its shipping partners. Similarly, if it turns out that it could have delivered 14 million tpy, it is seriously out of the money. Either way, the producer gains a sub-optimal return on its investment.

On the other side of the contract, the shippers need to be confident that they are able to supply the right ships at the right time, with the right tonnage and capacity to deliver the agreed volumes – all while allowing for boil off and bunker fuel. They therefore need to be confident that, allowing for weather, their ships can arrive, load, depart and deliver in a consistent fashion. Will typical wind speeds knock their vessels off their moorings? How often and how far does that infamous fog affect visibility and manoeuvrability? Will unusual delays at pilot boarding stations compound channel traffic bottlenecks?  Failure in any one of these areas opens the consortium up to bloated contingencies and costly mitigations.

Certainty in complex markets

In this case, advanced simulation provides the evidence necessary to make sound investment decisions, and creates the foundations for successful consortia to plan and deliver annual delivery programmes. By exploring and stress testing thousands of different scenarios, and using probabilistic techniques to understand the consequences of different variables, all parties can proceed with much greater confidence that the outcome of their partnership will be as expected. The value of simulation here is not just that it can provide insight into what will happen within normal weather parameters, but also the effect of the extreme weather conditions that periodically prove so disruptive.

Of course, what the US producers are facing is an entirely familiar problem. Their counterparts in Asia and Australia have long had to navigate their way around typhoons in the South China Sea, and ensure delivery through the Strait of Malacca.

But in light of volatile market prices and fluctuating demand patterns, the industry as a whole is demonstrating greater reluctance to fix its costs. Newer players are looking for a more flexible approach, and the use of simulation and modelling to continually re-evaluate initial positions is set to increase. As competition in the LNG market heats up, the room for guesswork, hunches and uncertainties get ever smaller.

Written by Lanner. Edited by

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