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LNG Ready to Break Free from Crude Oil Linkage, Execs Say

With the rise of U.S. liquefaction capacity helping to give liquefied natural gas (LNG) buyers around the globe more options than ever before, LNG is ready to step out of crude oil’s shadow and stand as its own commodity, according to a panel of executives for leading industry players.

Challenges remain to establish a transparent pricing mechanism and sort out a sustainable business model for the next wave of projects, but the LNG market is rapidly becoming a commoditized business, transitioning away from the long-term, oil-indexed contracts that have characterized the global LNG trade for years, the panelists told an audience at the World Gas Conference in Washington, DC.

“The time has come, or it’s coming very fast, where you’re not going to be able to link” crude oil and LNG “together anymore,” Woodside Energy Ltd. CEO Peter Coleman said. “There’s a long history of why they were linked, but my view is the sooner they’re delinked, the better, when we can get a true regional pricing model in place that really reflects the cost of supply.”

Oil linkage “drives two particular behaviors,” he said. “One is it always says LNG is going to be tied to crude oil, and it always says LNG is subservient to crude oil. And it’s not. LNG should go and stand on its own, as its own commodity and traded marketplace.”

Oil indexation for LNG contracts is also problematic in that it “drives the mentality around the amount of money that we can spend on projects,” Coleman added. “While we think that the crude oil fairies are going to help us out on this, we’re kind of victims of our own past, and we will often go and spend more money than we need on projects” as crude oil forecasts show an “ever-increasing trend” that doesn’t reflect the cyclical realities of commodity prices.

“What we need to do is actually start to match the investments that we make to the actual commodity itself.”

Tellurian Inc. Chairman of the Board Charif Souki, the U.S. LNG vanguard and former Cheniere Energy Inc. executive who oversaw the development of the first Lower 48 export facility at Sabine Pass, LA, echoed Coleman’s comments on the future of oil indexation.

“I don’t understand the correlation anymore; it makes no sense,” Souki said. “At the moment, if I had to connect gas prices to oil prices, I would be in fear. I would be saying that the last 10 years have proved to me that this could be a very expensive proposition, and do I really want to expose myself to that situation again if I can simply sit in the spot market” to get supply.

“So I don’t really think that the indexation to oil is going to last much longer. I also think you’re starting to see some flexibility” in oil-linked pricing for LNG “almost depending on what prices are in the spot market,” Souki said. Oil-indexation “disappeared in Europe over the last decade, and I think in the next decade it disappears in Asia as well.”

Cheniere CEO Jack Fusco said he’s concerned about the potential for LNG prices to climb high enough to destroy global demand and open up opportunities for competing forms of energy.

“I think eventually we’ll see” a dissociation between oil and LNG prices, “but I don’t think it’ll happen anytime soon, because most of our LNG customers are managing a portfolio of different pricing mechanisms...and getting the volatility out themselves rather than having us help them get the volatility down,” Fusco said. “Having said all that, that’s what keeps me up at night. High oil prices leading to high commodity prices meaning more competition. The next thing you know it’s renewables, it’s solar, it’s wind, coal’s back again. So I think having a mid-level oil price like we have now is best for everybody.”

The obligations and need for predictability of some buyers in the global market -- such as utilities -- could also influence the pricing model, the executives said.

Fusco said the recent trends in the percentage of spot LNG versus oil-indexed contracts could see some volatility as new U.S. LNG capacity comes online.

“I think we may have given the market a false sense of security as far as the spot market,” Fusco said. “Because we were so early in our construction, we had a lot of cargoes that all hit the spot market. When you wax on about the percentage of spot versus fixed, long-term contracts, it looks like there is a lot of spot. Our contract portfolio is catching up to us.

“...I would think the percentage of spot long-term is going to be a little erratic and a little volatile” as new liquefaction trains start up in the United States.

Still, Souki said he doesn’t see the emphasis on long-term contracts being as necessary now that the LNG market is opening up.

“If you are a player today in the LNG market, it’s become almost necessary to be a trader also,” Souki said. “Because either you’re short and you have to buy when you really need it, or you’re long and you have to get rid of it when you don’t need it.”

The dramatic changes in the United States over the last decade thanks to unconventional shale development have helped spur new global demand, Souki said.

“You’re in a situation now where there is a goal of additional energy for markets around the world. The demand has responded to low prices, which in a commodity business you’d expect,” Souki said. But the market is “missing one last ingredient: what is the business model that is going to be sufficient in a commodity world to build the infrastructure that’s required in order to deliver the gas even in the face of a very clear demand for the gas and a very clear profit signal?”

Further, what pricing mechanism will prove sustainable enough to justify the investments needed?

“Are you going to be able to sustain that kind of margin for a long enough period to amortize a very expensive cost to build LNG infrastructure, not just liquefaction, but finding the gas, producing the gas, bringing it to the LNG facility. And every country has different challenges,” Souki said. “...In the United States, we have to deal with a spaghetti factory of pipelines that take gas very often in the wrong directions -- going to New York, going to Chicago, going to Los Angeles, not coming to the Gulf Coast where we want to build LNG facilities.

“...You have to put all this in context” and consider costs “not simply on the liquefaction side but throughout the chain, because you’re now in a commodity business, and in a commodity business the low-cost provider prevails,” he said. “...This is a big challenge for the next wave. How are we going to justify the investments that are necessary in order to meet the challenge” of growing global demand?

Coleman similarly opined that LNG suppliers should focus on costs first rather than fixate on the revenue side.

“What we have to do as suppliers is work our hardest and not worry about what our pricing is but focus on our costs,” Coleman said. “Because the only thing you ever know, the only thing you’re ever certain of at the end of a project, when you produce that first molecule, is how much you just spent.

“That’s the only thing you’ll ever know...that’s one of the issues that we have. We keep focusing on the revenue side thinking that price is always going to bail us out as an industry,” he said. “The reality is we should have focused more on the cost side, and I see that now. I see more people focused more on costs than they are on revenue.”

Still, for the right project with the right business model, financing won’t be an issue, Souki said.

“I think the world is awash in liquidity. There’s money everywhere,” Souki said. “There’s a shortage of projects that actually make sense on a short-term and long-term basis. I think if you come up with a valid business model that’s sustainable, finding the capital is not an issue.

“I said that eight years ago when we started Sabine Pass, and I still think that today. When we started Sabine Pass we were still coming off a recession. People were questioning whether there was money available or not. There was never a question in my mind that if we came up with the right business model, raising the money would not be an issue.

“...There is always money for new projects, but solving the riddle of what is the business model for the next decade is critical.”

Just as it’s changed rapidly over the last decade, the LNG market could look very different by 2025, according to the panelists.

Souki predicted that an Asian LNG price based on the Japan Korea Marker (JKM) will emerge “that is actually tradeable. There will be a Gulf Coast marker that will actually be tradeable that will be correlated to JKM” and to prices in Europe. The buildout of LNG infrastructure will grow the market “rapidly,” he said.

Coleman said LNG will break free from crude oil and emerge as a central component of the future global energy mix.

“I think you’ll find gas will move from being a transition fuel to being a base fuel,” Coleman said. “It will be very competitive with renewables and be totally complementary.”

 

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