Marijn van Diessen
McKinsey & Company
14:00 - 14:25
Thursday, 19 September 2019
S1.9 The Next Wave of LNG Contract Negotiations & Arbitrations
Ever since the first commercial LNG cargo was exported from Algeria in the seventies, the gas market has become increasingly global. Gradual at first but when Qatar accelerated its export in 1997 the intercontintental flows took off. Despite the increase in global flows, pricing has remained relatively regional. Since 2009 regional gas prices actually dislocated: high prices in Asia following the Fukushima events and low prices in North America as a result of the Shale boom. After 2015, the different regional prices started to converge as more LNG projects came on stream and portfolio players and independent traders were attracted by the high margins in LNG trading.
In future we expect a fundamental shift to take place in the market as the large amount of US projects coming on stream means the US will become the marginal supplier and with that the price-setter of LNG globally. This also creates a potential for a significant gap opening up between the oil-linked prices that many contracts still have and this new US gas-on-gas benchmark based on the Henry Hub prices. At an oil price of $70/bbl and a Henry Hub price of $3/mmbtu there is a potential of $1-2/mmbtu gap and with roughly 200mtpa of active contracts there is $10-20bn at stake annually, creating significant incentives for LNG buyers to trigger price-reviews, similar to the first wave of arbitrations that hit Europe in the beginning of this century.
For the last few years McKinsey has been surveying LNG buyers across the world for its LNG buyers survey. One of the questions asked to these buyers is how likely it is that they will trigger these price review clauses and a quarter of respondents has indicated that it likely or very likely they will do so in the next 2 years.
We believe a combination of the following events could trigger this second wave of arbitrations:
- Sustained difference between contracts and alternative sources (e.g., spot prices, new US projects): Current forward prices indicate roughly $60/bbl for Brent and $3/mmbtu for Henry Hub which means there are only minor difference between the two price markers. In a scenario where the oil price remains at levels above $70/bbl and Henry Hub remains at $3/mmbtu the gap will open-up again.
- Increased competition in destinations: the incumbent LNG importers in Japan, Korea and Taiwan have faced limited competition, which means they are still able to pass on their contract prices to end-users. When these market dynamics change (for instance through the liberalization of the market) it will create additional urgency for the incumbents to renegotiate legacy contracts. Similar to what happened in Europe when challengers emerged and the margin of the traditional midstreamer came under pressure as a result of the liberalization.
Re-negotiations and arbitrations are often inevitable, large impact, zero-sum and affect the entire portfolio. We believe it is absolutely crucial for companies to develop a strategy, prepare well and, when relevant, take a portfolio approach.