How Can Traders Navigate the New Order in LNG Markets?
How can LNG companies reposition themselves for success at a time when energy markets are in a state of transition, and much more complex?
By Sanjeev Gupta
Declining margins in oil trading, growing liquefied natural gas (LNG) demand and market liquidity have attracted a host of players to expand their presence in LNG trading. These include international oil companies (IOCs) and national oil companies (NOCs), commodity traders and LNG buyers, such as gas and power utilities. The top three commodity traders have more than doubled their LNG trading volumes over the 2016–18 period to reach nearly 9% of the global market.
LNG markets today are in a state that oil markets were in two or three decades ago. Arbitrage opportunities have led to a greater role of middlemen in connecting new and diverse sources of supply and demand, while managing associated risks. This has led to commoditisation of LNG. Unlike the point-to-point delivery from the liquefaction terminal to the end consumer in the past, LNG can now change hands multiple times, or take several routes to reach the market.
However, LNG trade is expanding at a time when energy markets are in a state of transition and much more complex. Additionally, LNG now competes with a wide range of alternatives, such as nuclear, coal and renewable energy, for its key use, power generation. The seasonality of gas demand and issues around long-term storage, boil-off and break-bulk add even more complexity.
LNG markets are currently oversupplied, with growing production, mild winters and full inventories. The situation is worsened by a loss of demand globally due to the COVID-19 crisis. LNG buyers have declared force majeure and cancelled cargoes. LNG flows into storage terminals in Europe, the market of last resort, have increased. Prices are depressed across markets and new LNG projects have been delayed around the world.
A key question is how LNG players can succeed in an increasingly competitive and currently oversupplied market. Customer-centricity, innovation and digitalisation will differentiate leading companies from less successful ones.
Companies will need to reposition themselves from being just a trader of commodities to be a provider of solutions. The first step is to understand customers’ needs and the circumstances they operate in, followed by designing and delivering tailored solutions that are powered by technology to meet them. Having the necessary skills, culture and operational flexibility to execute non-vanilla deals is also important.
Innovation and customer-focused solutions
The most common way to make money in LNG trading is by moving cargoes from supplier regions into growing gas markets that lack pipeline connectivity, while taking advantage of the regional price arbitrage. LNG traders also optimise their portfolio through spot trade as buyers prefer shorter and more flexible contracts amid surplus supply and low LNG prices.
More recently, in the absence of regional arbitrage opportunities, traders are using innovative options, such as destination and time swaps and trading oil-linked cargoes against spot cargoes, to make profits and provide buyers with flexibility. For example, an investment bank has offered its LNG customers the option to choose alternative ports to deliver LNG cargoes for an up-front premium, which allows them to manage arbitrage risk.
Innovation is also happening around pricing, although to varying extents in different regions. For instance, US LNG deals are being indexed to the Japan Korea Marker, an Asian benchmark, and an oil major has agreed to sell LNG to a Japanese utility, with the price indexed to coal. As LNG markets globalize and competition among various fuels affects their pricing, demand for cross-commodity, structured products and risk management will rise.
Lack of infrastructure is one of the key challenges in Asia, one of the fastest-growing LNG markets. Liberalisation in many emerging markets is bringing small, private and often inexperienced and risk-averse LNG buyers to the market. Commodity traders are helping to develop LNG import and regasification infrastructure in new import markets, such as Pakistan and Bangladesh, and extending credit lines to buyers with low credit ratings.
Innovative financing models are also being developed. Increasing spot market share is changing the financing model of liquefaction facility projects, previously backed by long-term contractual commitments. LNG players are switching from traditional project finance toward balance sheet financing, using retained earnings as well as raising debt or equity. This model is only feasible for IOCs and NOCs with significant financial resources. Some projects in the US are experimenting with new risk allocation approaches by offering equity stakes in liquefaction terminals to potential industrial or financial partners.
Apart from deal structures driven by broader industry trends, innovative and bespoke deals that solve customers’ unique problems can also help to differentiate gas and LNG traders. For instance, an investment bank has designed innovative deal structures combining the physical supply of natural gas with tailored payment terms allowing buyers to defer payments and manage their working capital.
TECHNOLOGY AND DIGITALISATION
Companies across industries and geographies are investing in digital technologies to optimize operations across the value chain, reduce costs and enhance customer experience — and this is no different for the LNG business. Advances in technology, including floating production plants, import terminals, and ship-to-ship transfer, have made it easier to connect new markets and help expand LNG trade.
Customer-focused digital platforms are increasingly using digital LNG exchanges to help buyers and sellers trade LNG online. For instance, an online bunkering platform created by a digital solutions provider for risk management and a Netherlands-based logistics service provider allows ship owners and operators to order LNG bunker volumes and access business intelligence.
In addition, companies are analyzing satellite data with digital technologies, such as advanced analytics, artificial intelligence and machine learning, to track LNG cargo movements and plant shutdowns. These digital platforms are solving some of the most pressing issues in the LNG industry by connecting a wider set of buyers and sellers and ensuring last mile delivery of LNG.
SCALE AND OPERATIONAL FLEXIBILITY
The pressure on margins is forcing companies to increase their share in the value chain. Many are building scale and operational flexibility. For instance, large commodity traders are graduating to asset-backed trading by investing in export and import terminals and ships that carry the fuel. However, they are facing difficulties in acquiring assets due to scarce opportunities (as IOCs have stopped selling them) and less resources due to diminishing margins in the traders’ core revenues.
As part of their strategy, companies are setting up trading offices and building scale in the key import markets of Asia and Europe. For example, a major Middle Eastern NOC has opened an LNG trading office in Asia, while an Asian utility has started its trading operations in Europe.
Companies are also acquiring LNG trading businesses from European utilities looking to exit the market. LNG traders should also look out for new markets and applications, such as marine bunkering. The International Maritime Organisation 2020 regulation that limits marine sulfur emissions to 0.5% by 2020 may create a new market for LNG as an alternative marine fuel. Marine fleets around the world are switching partially or fully to LNG and the number of LNG bunkering vessels is on the rise. However, a lack of refueling infrastructure, especially last mile connectivity, and concerns over life cycle emissions, may limit uptake.
WHAT DOES THE FUTURE LOOK LIKE?
Global presence, financial strength, access to capital, logistical know-how and risk management capabilities are important drivers of growth for LNG traders. As LNG markets evolve to resemble oil markets, they will also have price and return cycles.
Companies that quickly recognise change, identify opportunities and innovate through creative solutions and new business models will be more likely to thrive in the long run. They will also need to identify areas of competitive advantage in the LNG value chain and adopt strategies to play to their strengths and meet their risk-return expectations.
There are no off-the-rack solutions or tools that can make companies innovative, customer-centric or digital leaders overnight. A tailored approach and organisation-wide changes will be required to successfully navigate the new order in LNG markets.
 “Commodity traders accelerate industry growth with LNG investments,” World Oil website, www.worldoil.com/news/2019/3/27/commodity-traders-accelerate-industry-growth-with-lng-investments, accessed 2 July 2020.
Sanjeev Gupta is EY Asia-Pacific Oil & Gas Leader and EY Asean Energy Leader.
The views in this article are those of the authors and do not necessarily reflect the views of the global EY organization or its member firms.