Global liquefied natural gas (LNG) markets have some growing up to do, and liquefied U.S. natural gas will play a role in the maturation process, analysts at Goldman Sachs said in a research note published Thursday.
Global LNG trade should surpass US$120 billion this year, overtaking iron ore to become the second most valuable physical commodity after crude oil, Goldman analysts said. As the industry matures, spot trade will account for a growing percentage of volumes as oil-indexation loses its appeal.
LNG producers will have to beat down project costs to stay economic in a low-price world; meanwhile, alternative pricing mechanisms are necessary to manage risks in the capital-intensive industry, Goldman said.
"In other words, there is a window for LNG to grow and become a normal commodity that is priced according to its own fundamentals rather than those of different, if related, commodities," Goldman said. For now, though, the LNG market is immature, with the commodity priced off of oil and/or domestic natural gas. This isn't ideal.
"For example, power utilities can manage their price risks in power and coal markets, but in the absence of an established LNG hub with an associated derivatives market they are forced to hedge their LNG exposure in the oil market," Goldman said.
Project costs have climbed, and the bottom has fallen out of the oil market, making consumers leery of stepping up for long-term contracts. However, there is some breathing room as the next round of investment can be delayed until capacity now under development is absorbed and project costs are rebased, Goldman said. This gives suppliers some breathing room to cut costs and explore pricing mechanisms that allow for hedging that is attractive to to other market participants.
Since regasified LNG will compete with thermal coal in the power generation arena, it should be priced off of its own fundamentals, as is coal, Goldman said. "The question is whether this transition, via the development of an LNG trading hub with a liquid derivatives market can occur in time for the next wave of investment due to be approved towards the end of the decade."
Goldman's analysts wrote that they believe U.S. LNG could be a catalyst for change in the global market, with U.S. exports doing more than merely increasing supply diversity for LNG consumers.
U.S. terminals generally have adopted a tolling model, and this will lead to a greater availability of spot LNG cargoes as these terminals come online. Price arbitrage between Henry Hub and global LNG markets will drive the business rather than long-term contracts. An absence of price correlation between U.S. and other markets should make for a high level of volatility, Goldman said.
"Thereby lies part of the appeal of U.S. projects, whose option value increases with volatility," the analysts said. The arbitrage play will widen and narrow periodically due, for instance, to weather conditions in the United States and Europe/Asia. "We believe that the U.S. will become the world's third-largest LNG supplier by the end of the decade but its capacity utilization rate across the cycle may be below the global average," Goldman said.