Akin Glump Strauss Hauer & Feld LLP
16:50 - 17:15
Thursday, 19 September 2019
S1.10 Profiting from LNG Netback Pricing
While netback pricing models are now often utilized in US crude oil sales agreements following the lifting of the ban on crude oil exports in 2015, the US LNG industry has been slow to adopt netback pricing. There are structural reasons for this. With few exceptions, most US LNG projects have been dependent on contracting take-or-pay commitments from creditworthy buyers or tollers at a price expected to support project development costs and acceptable returns to sponsors, and not dependent on securing gas supply. Unlike many international LNG projects which rely upon dedicated upstream reserves and infrastructure to justify development, the robustness of gas supply in the US spot markets generally obviates the need to secure supply in advance (and thus offer incentives, such as netback pricing, to producers to secure supply commitments).
But market conditions have changed since the “first wave” of LNG projects were financed and developed. Today, many of the “second wave” of LNG projects are struggling to advance in a market where the pool of buyers is generally less creditworthy, less willing to commit to long-term take-or-pay commitments and/or less willing to enter into transactions with unhedged exposure to Henry Hub pricing.
To advance new projects it is time to re-think the relationship between LNG developers and marketers and the upstream industry. Indeed, by offering producers a netback price for feedgas supply, LNG project developers, marketers and other participants have the potential to enhance their US LNG projects and overcome existing challenges.
At its core, netback pricing is a function of determining the applicable sales price of LNG (or RLNG) sold (based on either resale proceeds or, more commonly, an index price with a basis adjustment) less all, or substantially all, costs incurred in the value chain from the wellhead to the applicable sales point. The sizzle in netback pricing, from a gas seller’s perspective, arises from the potential for a gas seller to realize a higher net price for its gas production than the local market price, and from a gas, LNG or RLNG buyer’s perspective, the potential to, among other things, source feedgas at a price that is potentially lower than the local market price for feedgas supply.
This paper will discuss key considerations in negotiating a US LNG transaction utilizing netback pricing. Drawing upon the author’s experience in netback pricing outside of the US and in crude oil sales, the paper will also highlight various methodologies by which costs would be allocated among LNG participants, together with protective provisions such as collars, floors, caps and shared-revenue sliding scales, credit support and structuring matters under the netback model, potential challenges in effecting such transactions due to royalty owner claims (e.g., will royalties be required to be paid based upon US gas prices or LNG or international power prices and can producers deduct the costs incurred in the value chain in calculating royalties) and legal strategies as it relates to such potential claims.