Figure-1: Trend in LNG liquefaction capacity sizes. Source: LNG Journal March 2015
It is well said that formulation of a strategy is a dynamic concept – a strategy formulated in the year 2000 for example, may not work in 2015, as key parameters – global environment, market dynamics and other factors may have changed with the passage of time. In the past the global LNG industry has gone through various phases in terms of technological advancement and market. For example, liquefaction train capacities were barley 0.37 million tons per annum (MTPA) during 1960s. Later, with the technological innovation it gradually increased to 1, 1.2, 1.5, 2.5, … reaching to 7.8 MTPA during the era of 2000 to derive economies of scales. Now 8.4 MTPA is planned to be constructed by Shell & partners in Nigeria. The train capacities in the range of 1 to 5.5 MTPA however, are still common and under construction depending upon the available gas resources and requirements of producing countries (Figure-1).
On the transportation front, LNG carriers are also getting bigger and bigger with the passage of time ranging from 18000 cubic meters (CM3) to 266,000 CM3over five decades of LNG history. However, the LNG carrier of capacity less than 150,000 used to be quite common in the past but only during the last decade the trend of over 200,000 CM3 to deliver larger volumes to their customers across the continents joined the LNG fleet (Figure-2).
Figure-2: Trend in LNG carrier’s capacity. Source: LNG Journal March 2015
Over the five decades of LNG history, the world has also witnessed various flip flop episodes from sellers to buyers and buyers to sellers market though historically it was biased in favor of sellers. The long-term contracts were linked to crude oil prices, annual contracted quantity (ACQs), destination restrictions besides other conditions. Since the early 2000, the demand for LNG increased rapidly in Europe and two emerging economies China and India in addition to traditional market. The supply side also expanded as new LNG hit the market. The biggest upset to the traditional LNG market was observed during the late 1990s and during 2000s when Qatar aggressively developed its North Field and within a short period of over a decade became the world’s largest LNG producer and exporter. Later, Australia also decided to expand its LNG supplies aggressively. The entry of both Qatar and Australia as major suppliers has changed the dynamics of LNG industry, which has been dominated by Indonesia, Malaysia, and Algeria. Qatar edge over other pioneer LNG producers due to its market proximity, large gas reserves and constructed the world’s largest LNG trains and LNG carriers to maximize economies of scale.
During this flip flop process buyers also started taking advantage of the tail wind, which in the past always has to face head wind. As a bulk of LNG supplies available from alternative sources particularly from Qatar and Australia during early 2000s, both China and India are taking advantage of buyers market in securing attractive LNG prices for the first five years. The abundant supplies from alternative sources also allowed the new buyers to change the SPA terms in their favor – introducing “S” curve protection removing of destination clauses etc. That is, industry quickly adjusted to the new environment and was quite accommodative to meet the new challenges.
Dilemma of Fixed ACQ
The rational of ACQ in LNG sale purchase agreement (SPA) is to protect the seller’s huge upfront capital investments. Companies must secure buyers for this minimum quantity before FID is made. In the past, this mechanism was working quite well and there were no issues however, during the year 2015, after collapsing of oil prices, weaker LNG demand and more LNG supplies created a situation where LNG spot prices fell below the contracted prices. The reason being that the oil prices went down below the minimum threshold level of protected “S” curve below which LNG prices are insensitive to oil prices. As a result, spot prices fell below the long-term contracted formula based prices. In an environment of weaker domestic demand and lower spot prices, buyers were reluctant to lift ACQ rather they preferred to take advantage of buying spot cargos (WGI Aug.5’15, WGI Jul.15’15). On the other hand, during the period of higher oil prices, higher demand, buyers were interested in lifting more than the ACQs. As oil prices increase more than the “S” curve protection of upper limit it is beneficial for the sellers to sell un-contracted quantity in the spot market (spot prices exceeded over contracted prices). But for buyers this is certainly not a pleasing situation. In other words, issues of ACQ emerge whenever oil prices exceeded/reduced above/below the agreed price band (or some unusual demand/supply increase/disruption). From the seller’s perspective, they like to protect their investment and ensure desired rate of return by selling the desired ACQs.
Challenges for LNG industry
The challenges for global LNG industry are enormous especially for the LNG sellers. The weaker global economic growth particularly slowing down of Chinese, Indian economies as well as struggling Europe, Brazil, Russian and Japanese economies will be alarming. In addition, Japan being in the process of re-starting a number of nuclear plants will further depress the LNG demand which increased quite a bit after the Fukushima incident in March 2011. Figure-3 highlights the new LNG hitting the market in 2015, 2016 and during 2017-2020. During 2015, a total of 38.5 MTPA added to the global supplies – major supplies coming from Australia 35.3, Indonesia 2 and Malaysia 1.2 MTPA. In 2016, 68 MTPA will hit the global LNG supplies, major portion coming from the USA. However, during 2017-2020 if all identified projects at various phases are materialized (excluding projects that are under study stage), then we are talking about 346 MTPA capacity to be added to the global LNG market.
As more LNG available than the demand, buyers have edge over the sellers and they will try to avail this opportunity in renegotiating the terms of the agreement – including demanding the changing of weights, oil price band and also look for flexible ACQs (maybe linking with increase/decrease in oil prices). Buyers should not be adamant as the industry is dynamic and current situation will change quickly to the advantage of sellers – this is what we have learned from the history. In all fairness buyers should understand the huge capital upfront investment of billions of dollars (Australian Gorgon cost $54 billion) by the sellers and exposure to risk they have every right to maximize return on their capital. Both the buyers and sellers work in amicable manner and try to formulate the terms taking into consideration extreme eventuality protecting the interest of both the parties.
No doubt, more LNG supplies will accelerate the development of spot markets by allowing both the buyers and sellers devising a mechanism of flexible ACQ, providing some room of flexibility to take advantage of market conditions. More LNG supplies will also facilitate in rationalization of LNG prices – reducing the large differential across the continents.
Figure-3: New LNG supplies. Source: LNG Journal March 2015
Given the huge LNG supplies coming on stream during 2015-2020 and even thereafter, it appears to be a difficult period for LNG sellers. However, with appropriate investment and marketing strategy these challenges may be converted into opportunities. In order to take advantage, understanding the future market dynamics is the most critical factor in devising the appropriate strategy.
First of all, sellers have to develop a new strategy to retain their existing buyers and then look for new customers. They have to be proactive in securing their current buyers by taking lead in finding out and addressing the concerns of their clients, providing some flexibility in adjusting ACQs (linking with the oil prices or some other flexible mechanism), finding smaller countries that have the potential demand but lack risky capital, also make investments in (Floating Storage and Regasification Unit) FSRU, invest in floating storage facilities, allowing to sell LNG in high seas to shipping industry as a fuel of choice. In addition to long-term contract short term agreement would also expect to be common. In fact, the future LNG market would be like a distribution company to supply LNG wherever it is required. To meet the demand of smaller consumers, industry may have to make investments in smaller LNG carriers (fashion of 1960s), LNG bouzers, floating storage facilities, FSRU as well as considering investment in power generation in target countries to secure LNG sales. It may look like an irrational idea now but the way LNG spot market is expected to develop LNG business would be shifted towards spot and short-term sales. The companies which foresee the future correctly and accordingly adjust their strategies will be clear winner in capturing the market share. LNG usage in transport sectors will further enhance the demand and more of LNG projects would be added to meet the ever increasing demand for environmental fuel of choice for power and transport sectors.
 Theses are preliminary analysis/thoughts of the authors and does not necessarily reflect the views of Qatar Petroleum. Strictly confidential for internal use only.
Mian Aneesuddin is Specialist Oil and Gas Industry, Portfolio Assessment and Economic Evaluation
 Though there are some smaller size of cylinder of few thousands were also constructed.
 Authors wrote article in March 2013 warning this situation of adjusting ACQ would be hot topic in view of massive LNG and softer oil prices.