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Evolving capabilities in an evolving LNG market

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LNG Industry,

‘Short-termism’ is growing in the LNG market, which is increasingly characterised by greater spot availability, shorter term supply contracts and buyers diversifying their portfolios to capitalise on the current market oversupply. The trend is driving both LNG buyers and sellers to consider how their capabilities need to evolve to compete successfully in such a market.

Over the last few years, there has been a significant shift towards shorter term sales contracts - the average length of a term contract signed in 2015 was just 8 years, compared to 15 years in 2008. This trend is likely to continue, with McKinsey’s own survey of LNG buyers and experts suggesting that more than half expect their next LNG term contract to be a 5 - 9 year deal.

The ‘short-termism’ is also reflected in a reduced likelihood that buyers will renew their existing term contracts. In McKinsey’s survey, two thirds of buyers with existing contracts reported that the chances of renewing those contracts were either ‘somewhat unlikely’ or just ‘possible’. The most significant reason for this was that the supplier was not felt to be price competitive (38 out of a possible 100 points). However, interestingly, supplier under-performance and inability to guarantee future volumes were also important, accounting for nearly 27 out of a possible 100 points.

Both buyers and sellers need to evaluate their capabilities and readiness to compete in a market characterised by this ‘short-termism’. Sellers, in particular, face competitive pressure in a market in which their traditional buyers are less likely to renew their long-term contracts and are more inclined to diversify their portfolio.

Sellers should consider developing their marketing capability in ways likely to be relatively unfamiliar to many in the LNG industry. For example, it is no longer sufficient for sellers to interact with buyers at just two major junctures - contract negotiation and operations. Instead, sellers need to be focused on the entire ‘buyer journey’ - from understanding buyers’ demand drivers through to the dynamics of supplier loyalty and assessment. By approaching marketing and trading in this way, sellers are better able to understand core buyer ‘wants’ and buyers’ willingness to pay. Sellers can then tailor their offer accordingly, by, for example, providing financing or engineering support for the buyers’ infrastructure projects, or providing volume or destination flexibility. This represents a step-change in thinking over traditional approaches to B2B marketing in the LNG space.

Sellers will also be required to become more nimble with greater deal churn as a result of shorter term and potentially lower volume contracts.

Buyers’ capabilities also need to evolve, and not just for those over-contracted buyers who have recently found themselves in a position of having to also be a seller of LNG. Buyers with the most sophisticated sourcing capabilities can screen the differing dynamics of sellers to find the most suitable for their needs. After all, the market has evolved from being dominated by IOC and NOC suppliers to one that includes multiple seller types, ranging from regional portfolio players, independents and traders, to over-contracted buyers. This variety of choice means buyers can develop a more flexible suite of supply options, but the lack of term certainty means development of risk management capabilities is also required.

In the current shifting LNG market, it is important to be aware of the accelerating trend towards greater short-termism, fed by competition from an increasingly wide variety of supply side participants. Maximising the revenue of LNG supply operations in a market that is relatively oversupplied and more short-term focused than has been the case in the past, will require a revised set of marketing skills and techniques. Buyers too should develop new skills, including the ability to assess seller capabilities, and manage the less certain and more complex supply portfolios available.

Written by James Walker, McKinsey Energy Insights.

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