Out of the Box Approach – LNG Pricing
The pricing methodology of LNG has been evolving form so many years, right from the beginning when the LNG trade first started.
1. Buyer and supplier agreed for a slope which is at way discounted with crude oil, say 5-8% of crude with floor to protect supplier and ceiling to protect the buyer.
2. When the trade increased with more usage of LNG and demand is getting higher, the new concept of “S” curve was introduced, which was again for protecting the interest of buyer and seller but in a way that the revenue if not frozen with a number under the volatility of crude oil prices.
3. There comes an era when the demand of the LNG increased significantly and surpassed the total supply of LNG across the Globe and the ra was termed as Seller’s Market where the market sentiments revealed that the market will always remain aggressive and there is no looking back for the price to go southwards. Here the sellers started offering straight line formula and were ready to take risk on low crude oil price scenario, which they presumed will never happen.
Now comes the most volatile market with economies going berserk, demand of energy declining sharply, supplies of gas increasing exponentially, shale gas revolution resulting into self sufficiency of US in oil as well as gas. These market conditions have actually created three distinct market of Gas where the prices are different in these markets and ample of opportunities were available for arbitrage and with glut in LNG supply the buyers are not accepting the straight jacket formula linking with crude. The buyers are uniting to breach the monopoly of suppliers to de-link the LNG market from crude as they feel that this is now an independent commodity which should be linked to certain gas based benchmark.
With the advent of US LNG export a new bench mark i.e Henry Hub (HH) came into the picture. Thereafter now various suppliers are creating innovative and out of the box type of formula such as:
1. Hybrid pricing including the HH and crude linkage which can fetch the benefits of both the market conditions as there is no direct correlation between HH and Crude prices.
2. Hybrid pricing with straight line with HH and “S” curve pricing with crude linkage wherein the kink point are the negotiable elements between the parties.
Hybrid pricing inclusive of all the established bench marks such as HH, NBP and Crude linkage, however in all the above formula the weightage to each of the bench mark was also the negotiable element amongst the parties.
Considering the above, it seems that in future supplier should also think of following innovative and relevant pricing methodologies for LNG specific to the market.
A. For Asia Pacific market the bench mark is being developed by various agencies which may be used by the suppliers for pricing, however, the way average JCC i.e. Japanese Custom Cleared crude is getting published every month, the average JLNG price inclusive of all the long term, medium term and spot cargoes is being published every month by Japan and this could be a very efficient bench mark for the JKT market which reflects the average price of LNG which is being consumed in the region. The pricing based on JLNG with discount or premium to netback is new way to approach buyers of JKT.
B. I had tried to evoke interest in my earlier article which states that due to volatility of HH, the buyers are not confident of the estimates of their cost of feedstock and the principle of “S” curve can also be applied for LNG pricing for almost all the markets. The pricing thus would be “S” curve on HH pricing with levels of HH price kinks would be negotiable elements .
C. Considering the 55 MMTPA US LNG supply coming on stream, which would generally be sold on Spot sales, the LNG market is surely be maturing with spot sales percentage increasing to 50% of the LNG trade. Supplier can introduce a hybrid formula which may have two component with one element linked to any of the formula as discussed above and second element as the price discovered in spot sales for that particular market.
The percentage of each of these two elements can be negotiated and the formula would look like: 50% of JCC linked LNG price +50% of monthly average spot LNG price as published by ICIS/Plats/Argus.
This will satisfy the customer as the spot price will cover the actual price governing the market at the moment and this would be a win-win situation for bot the buyer as well as supplier as spot will govern the price as is being happening in the oil market.
D. Last but not the least alternative can be the pricing of LNG with the alternative fuel which the LNG is going to replace. In Indian context, the Fuel Oil (FO) is the fuel which would be replaced by gas and the suppliers has to establish its correlation with LNG prices by regression analysis for different averages ranging from one month to 12 months and find out the average slope for theses months. Based on this slope the supplier can offer the LNG price at a premium to this slope stating the efficiency factor of Gas vis-a-vis FO. The price of FO can easily be hedged in the international market at a very competitive price and the seller can protect its interest.
Therefore another out of the box approach to LNG pricing is to establish the relation between the alternative fuel which would be replaced by LNG and sale is to be done linked with the price of the fuel with premium, which will ascertain the buyer that they would be always in line with the earlier fuel with a little bit of premium and this will assure the buyer of its estimation of cost of its feedstock.
Considering the evolving LNG market, these are the few pricing methodology which the LNG suppliers can adopt depending on the Market and affordability of end consumer, since they will have the portfolio of various market segment, they may average out the FoB break even for the LNG project.
About the Author
Krishnakant Joshi is the Vice President Marketing LNG/Gas at ONGC Videsh. He is also an alumnus of IIFT.